Interest rates trading in wild swings, Donald Trump scoring a thumping victory, the war in Ukraine raging on in its third year, Israel attacking Hezbollah directly in Southern Lebanon, Bashar Al-Assad ousted from power in Syria. For investors in emerging markets the calendar year 2024 could have been an exceptionally bumpy ride. In contrast to the noisy news flow however, returns accumulated steadily throughout the year and investors in hard currency sovereign and corporate bonds benefited from a move lower in risk premiums that accelerated after the summer. Riskier credits outperformed in general with spreads compressing between rating segments. High starting yields were an additional factor that over time helped with investment returns for investors in emerging market debt. However, for dollar-based investors in Local Currency markets, the strengthening greenback negated the positive return from stable interest rates.
Figure 1: Total Return as of December 17:
Sources: (1) JP Morgan, as of 12/17; (2) ICE Data, as of 12/17.
Looking ahead, markets seem content with a buoyant outlook for the US economy, while more cautious tones around the prospects for European economies often prevail. The latter could lead to a strong case for continued policy rate reductions by the European Central Bank, while the prospect of a deep cutting cycle by the US Federal Reserve seem more distant at this juncture. Productivity gains, partly from the advent of new technologies such as Artificial Intelligence and partly driven by a surge in labour supply from immigration in the United States, could keep growth in the US elevated while not necessarily adding strong inflationary inertia. With Donald Trump assuming office, policy making is likely to turn more ad-hoc and transactional; for example, whether he implements the full swathe of muted tariff hikes is not yet clear. Markets are currently expecting a reasonably benign outcome of Trumpian trade policy with plenty of room for bilateral appeasement proposals. For example, it is quite likely that in the event of a curb of migrant flows through the Southern border, tariffs on Mexican goods and services will be lower.
Figure 2: EM Central Bank Policy Rates
Under Last Move, red text indicates rate hikes and green text indicates rate cuts, corresponding to Months since last hike and Months since last cut. Similarly, red and green text under Rate change columns represent rate increases and decreases, respectively.
Sources: Egypt, Policy Rates, Central Bank of Egypt, O/N Deposit Rate;Nigeria, Policy Rates, Central Bank of Nigeria, Monetary Policy Rate;;South Africa, Policy Rates, South African Reserve Bank, Repo Rate; China, Bank Prime Loan Rates, People's Bank of China, Total, 1 Year; India, Policy Rates, Reserve Bank of India, Repo Rate; Indonesia, Policy Rates, Bank Indonesia, BI Rate; Poland, Policy Rates, National Bank of Poland, Reference Rate; Hungary, Policy Rates, Central Bank of Hungary, Base Rate; Romania, Policy Rates, National Bank of Romania, Monetary Policy Rate; Turkey, Policy Rates, Central Bank of the Republic of Turkey (TCMB), 1 Week Repo Rate; Mexico, Policy Rates, Bank of Mexico, Overnight Target Rate; Brazil, Policy Rates, Central Bank of Brazil, SELIC Target Rate; Argentina, Policy Rates, Central Bank of Argentina, Monetary Policy Rate; Chile, Policy Rates, Central Bank of Chile, Daily Monetary Policy Rate; Colombia, Policy Rates, Central Bank of Colombia, Policy Interest Rate.
Many emerging market countries are in the midst of cutting policy rates (see Figure 2 above). Inflationary pressures have abated across regions and interest rates less inflation have surged to levels where policy makers see them as too restrictive for their local economies. Some countries have implemented well received structural changes that necessitated large adjustments to exchange rates and currencies, for example Egypt and Nigeria. Both have now much better balanced external sectors, where trade and capital flows are less distorted. Structural reform implementation that addresses such imbalances, excessive deficits or deals with sectoral problems in an economy is likely to remain an important driver for risk premiums in 2025, and we look out for countries that are well placed to reap the rewards from such efforts. Elsewhere, generally healthy corporate sectors and strong consumer demand, in spite of high interest rates, yielded growth outcomes that often surprised to the upside. This is certainly the case for Brazil, where despite the reversal of the cutting cycle and surging real interest rates, growth in fact accelerated to 3.5%. The Brazilian central bank, one of the most pro-active rate setting institutions worldwide, has stated in its most recent communication that it must anchor inflation expectations in light of loose fiscal policies. If this becomes a new global trend and if the Brazilian central bank becomes the canary in the coal mine for the second time after its early hiking cycle in 2021, it will be a major focus point for markets in 2025 in our view. High fiscal deficits have appeared in several developed and emerging markets; how this translates into asset prices could determine investment outcomes for many countries in 2025.
Figure 3: Brazil: Strong growth despite high real interest rates
Source: Central Bank of Brazil. Data as of December 1, 2024.
Market concerns over a more difficult funding environment amid globally elevated interest rates did not materialise. Emerging market issuers could cover issuance needs with relative ease as demand for emerging market bonds showed signs of good health throughout the year. Furthermore, several sovereigns emerged from defaults or agreed with investors to restructure external borrowings into new securities. This will in due course likely lead to ratings upgrades and broaden the investor base that can hold such securities. A lower share of defaulted securities in the universe should also broaden the appeal of the asset class to global asset allocators.
Figure 4: Emerging Market Yields
Data as of December 18, 2024.
Source: JP Morgan, HC Corporates: JP Morgan, CEMBI Broad Diversified, Face Constrained Broad Index, Stripped Yield to Maturity; Hard Currency Sovereigns: JP Morgan, EMBI Global Diversified, Face Constrained Index, Stripped Yield to Maturity; Local Currency: JP Morgan, GBI-EM Global Diversified, Index, Yield.
Valuations for emerging market bonds have become less attractive as spreads rallied throughout 2024; however, the surge in US treasury yields and new entrants into the investment universe kept the overall yield level at almost the same level as where the year started (7.85% vs. 7.71% for sovereign bonds, 6.76% vs. 6.73% for corporate bonds and 6.19% vs. 6.36% for local currency bonds. See Figure 4 above). Looking at historical periods, such starting yields have often resulted in positive returns for the subsequent calendar year. The attribution of returns could look quite different however and we anticipate many opportunities for country and corporate credit selection in 2025. We note that the range of forecasts for the main economies and markets has narrowed substantially, a situation that makes us alert to information that could challenge the consensus expectations. For example, a bullish outlook for the US economy and a benign view of the incoming Trump administration have led to lofty forecasts for risky asset classes. A strong dollar view and expectations for a generally steeper US yield curve are now often appearing among forecasters, while downbeat views for European and Chinese prospects for economic advancement are similarly common among prognosticators.
Despite our increased vigilance aimed to identify a departure from a risk supporting market environment, we remain optimistic that in the near term investors in emerging markets get well rewarded for risks in the asset class.
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COMPARISONS TO AN INDEX
Comparisons to a financial index are provided for illustrative purposes only. Comparisons to an index are subject to limitations because portfolio holdings, volatility and other portfolio characteristics may differ materially from the index. Unlike an index, portfolios are actively managed and may also include derivatives. There is no guarantee that any of the securities in an index are contained in any managed portfolio. The performance of an index may assume reinvestment of dividends and income, or follow other index-specific methodologies and criteria, but does not reflect the impact of fees, applicable taxes or trading costs which, unlike an index, may reduce the returns of a managed portfolio. Investors cannot invest in an index. Because of these differences, the performance of an index should not be relied upon as an accurate measure of comparison.
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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.
USE OF ISSUER NAMES
Issuer names used herein are provided as examples for educational and illustrative purposes only and are not intended, nor should they be construed as, recommendations to buy or sell any individual security.
MacKay Shields LLC is a wholly owned subsidiary of New York Life Investment Management Holdings LLC, which is wholly owned by New York Life Insurance Company. "New York Life Investments" is both a service mark, and the common trade name of certain investment advisers affiliated with New York Life Insurance Company. Investments are not guaranteed by New York Life Insurance Company or New York Life Investments.
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