2018 Sector Teams' Outlook: Emerging Market Credit, Local Debt and Currencies

We expect a continuation of the positive emerging market (EM) trends in 2018, albeit with possibly more modest returns. An upward trend in growth in the developed and emerging world, continued stability in China’s economy, relatively stable commodity prices, broad-based improvement in sovereign and corporate fundamentals and supportive market technicals should result in a benign environment for EM debt and currencies. Although sovereign and corporate credits offer attractive yield pickup when compared with other asset classes, the most attractive segment of EM fixed income is local-currency denominated debt. With inflation stable or coming down and real interest rates (nominal yields minus inflation) relatively high, investors could benefit from high nominal yields and potential price appreciation of bonds.

There are some risks to this benign outlook. The trajectory of G3 central bank interest rates (Europe, Japan and the US) and lingering geopolitical events are a source of apprehension for EM investors. A poorly signaled change in the pace of removal of accommodative monetary policies by the G3 central banks would have a negative impact on most EM assets. US trade policy, specifically the North American Free Trade Agreement (NAFTA), is going to be at the forefront of issues in the first quarter and, depending on the outcome, could have significant impact on Latin America. In addition, EM countries face a heavy election calendar this year. Among those with a potentially large impact for EM debt are Mexico and Brazil. (The electoral campaign in Mexico starts at the same time NAFTA negotiations should be close to concluding. This combination of events could be negative for investor sentiment.) Although they have no official elections in the year, Turkey and South Africa are facing political risks that could also weigh on risk sentiment.

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