Market review

In December 2022, hard-currency emerging market debt¹ returned +0.33%, while local-currency emerging market debt² returned +2.16%. In 2022 as a whole, hard-currency emerging market debt has returned -17.78%, while local-currency emerging market debt has returned -11.69%.

In hard-currency emerging market debt, there was a negative impact from US treasury yields, with the 10-year treasury yield rising by 27 basis points (bps) over the month to 3.88%. However, spreads moved in a more favourable way, with a tightening of 15bps over the month. Coupled with sizeable coupon income, the overall total return for the month was still positive. In local currency debt, the main positive driver over the month was FX, as emerging market currencies benefit from US dollar weakness over the period.

Outlook

The strong rally in emerging market debt toward the end of the year has reduced some of the value we had seen opening up in certain areas of the market, however, we remain cautiously optimistic on the asset class as a whole. The reopening of China, and the hopes Federal Reserve managing a ‘soft-landing’, are the key driving reasons for the improvement in sentiment and improved performance of risk assets toward the end of the year. If US inflation data continues to come in below consensus, this is likely to lead to further pricing out of rate hikes and thus provide a boost to emerging market currencies, as dollar strength founded on interest rate differentials should lose further steam.

Less positively, It is likely that, given low levels of primary issuance in 2022, we will begin to see more primary market activity from January, which provides a negative supply outlook. However, despite the technical headwind of likely increased primary issuance, EM remains an underweight for global investors, which should provide some support to the asset class as sentiment improves and flows return.

With global food and energy prices having peaked, we believe that inflation should decelerate in 2023, and we have begun to see some emerging market central banks pause their rate tightening cycles. Brazil and Chile are countries that are leading the way in this regard.

Footnotes

¹As measured by the JP Morgan EMBI Global Diversified index

²As measured by the JP Morgan GBI-EM Global Diversified index (unhedged in US dollar terms)