Investors in Emerging Markets (EM) enjoyed two favorable trends in the third quarter: falling core interest rates and lower risk premiums. Combined with a broadly weaker US dollar, this resulted in strong returns for EM hard currency as well as EM local currency bonds. Speculation about whether the US Federal Reserve would initiate its easing cycle with a substantial 50 basis points cut or a more modest 25bps reduction to the Fed Funds rate ended when the rate setters opted for the bigger adjustment. The Fed communicated that this move was not due to concerns over the economic outlook, but rather due to moderating inflationary pressures, which gave renewed impetus to investors. Interest rate markets over the quarter anticipated the Fed’s decision by repricing shorter dated yields by over 100 basis points and longer tenors by around 60 basis points.
3Q 2024 performance*:
¹ Data as of October 8, 2024
² change in yield to maturity
Source: JP Morgan
Emerging market returns for the third quarter at the country level were generally dispersed along expected market sensitivities. Higher yielding countries benefitted from the general easing in financing conditions by a 72 basis point move in their risk premium, while Investment Grade rated countries only saw a marginal extension of their risk premium by 5 basis points. However, returns for investment grade rated countries were still close to their higher yielding peers due to their stronger ties with core interest rates. Furthermore, oil sensitivity was an explanatory factor for country returns, with exporters generally underperforming in Q3, as crude oil prices traded softer. Angola, Kazakhstan, Gabon and Colombia fell into this category. Some structural reform successes, namely in the highest yielding countries in Latin America (Argentina, Ecuador and El Salvador) propelled this group to the top of the return table.
Political and geopolitical risks, which dominated news cycles since the turn of the year, have continued to hold sway over markets. Going into the fourth quarter, the outcome of the US presidential elections, particularly if Donald Trump wins a new term in office, may lead to increased trade friction and meaningfully impact the geopolitical theatres in the Middle East and Ukraine. Israel’s campaign to strike at Hezbollah in Southern Lebanon is yet to find its conclusion amid rocket barrages from Iran and impending Israeli retaliation. Whether this turns into a more conventional armed conflict or if the conflict remains at the current ‘tit for tat’ level of ballistic missile exchanges will determine the path for the entire region. However, we note that despite the increase in belligerent activity, Middle Eastern risk premiums have not reacted meaningfully to the escalation.
Chinese policymakers announced substantial stimulus measures to address moribund domestic demand in the country. As a result of a multi-year slump in the Chinese real estate market, high unemployment, particularly among young people, and a general concerns over future prospects have led to reduced economic activity and very weak consumer confidence. While faced with these challenges, many Chinese citizens opted to save rather than spend, allocating ever higher shares of their stagnant disposable incomes to savings. Additionally, economic policies in recent years primarily targeted certain industries, for example advanced manufacturing, electric vehicles, solar panels and the petrochemical sector. This focus, combined with the lack of domestic demand, resulted in significant surpluses that were often sold abroad at discounted prices, inflaming international trade tensions. If the Chinese leadership can now address sluggish domestic demand more meaningfully, some of the excess could be absorbed domestically and thus better balance global demand. Due to the size of the Chinese economy and the sheer number of its consumers, invigorated Chinese patrons may become a catalyst for an upturn in global growth.
China consumer confidence
Data as of October 10, 2024.
Source: China Economic Monitoring & Analysis Center
Emerging market central banks have generally reduced policy rates in recent months and are expected to continue on that path amid widespread dissipation of pricing pressures. Notably, central banks in Eastern Europe and Asia have cut interest rates, while in Latin America most policy makers also followed the cutting trend with one major exception: the Brazilian Central Bank, which went against the trend and increased the Selic rate by 25bps to 10.75%, one day after the Fed lowered the Fund’s Rate by 50bps. In Africa meanwhile, the transmission mechanism from monetary policy to the economy is often dictated by movements in the foreign exchange rate. The pass-through from currency devaluations in Egypt, Nigeria and Angola to consumer prices prompted significant policy rate hikes in 2024 to counter the effect of higher import prices.
CB of Nigeria reacts to higher inflation with policy rate hikes
Data as of October 10, 2024.
Source: Central Bank of Nigeria & Nigerian National Bureau of Statistics (NBS)
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RISKS OF INVESTING IN emerging markets
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INDEX DESCRIPTIONS
JPMORGAN CEMBI BROAD DIVERSIFIED HIGH YIELD INDEX – JPMorgan CEMBI Broad Diversified High Yield is a sub components of the JPMorgan CEMBI Div Broad Composite Blended Yield Index, which cover the sub investment grade part of this composite index.
JPMORGAN EMBI GLOBAL DIVERSIFIED INDEX ─ JPMorgan EMBI Global Diversified Index is an unmanaged, market-capitalization weighted, total-return index tracking the traded market for US-dollar-denominated Brady bonds, Eurobonds, traded loans, and local market debt instruments issued by sovereign and quasi-sovereign entities.
JPMORGAN EMBI GLOBAL DIVERSIFIED INVESTMENT GRADE INDEX ─ JPMorgan EMBI Global Diversified (EMBI Global Diversified) Investment Grade Index tracks total returns for U.S. Dollar-denominated debt instruments issued by emerging markets sovereign and quasi-sovereign entities: Brady bonds, loans, and Eurobonds that are rated BBB and higher. The index limits the weights of those index countries with larger debt stocks by only including specified portions of these countries’ eligible current face amounts outstanding. The countries covered in the EMBI Global Diversified are identical to those covered by the EMBI Global.
JPMORGAN GOVERNMENT BOND–EMERGING MARKET INDEX – JPMorgan GBI-EM Global Diversified (GBI-EM) series, launched in June 2005, is the first comprehensive global emerging markets index of EM local government bond debt. There are three root versions of the GBI-EM with a Diversified overlay for each version; GBI-EM Broad / GBI-EM Broad Diversified, the GBI-EM Global / GBI-EM Global and the GBI-EM / GBI-EM Diversified.
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