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Navigating the compelling opportunity set in emerging markets
Emerging market expert Anthony Kettle, Senior BlueBay Portfolio Manager, RBC BlueBay Asset Management, identifies the current opportunities in emerging markets. But as always, there are headwinds out there.
As we look towards the rest of 2023, on the back of a period of high volatility, there are a number of themes that would point to a positive outlook through a combination of tailwinds, albeit balanced by some potential risks.
Monetary policy orthodoxy
Emerging market countries are likely to benefit from a period of monetary policy orthodoxy in contrast to the developed market central banks where the hiking cycle, it can be argued, did not begin early enough and therefore is likely to last longer. In emerging markets, various central banks have been raising rates since 2020 thus establishing a healthy real rate in several countries (though not all). The key beneficiary from this would likely be local assets. Strong local markets also tend to promote stability in their respective country’s hard currency credit markets, at both the sovereign and corporate levels.
Improving current account balances
Current account balances, the overall size of deficits and surpluses, across many emerging market countries have been improving through a combination of higher export commodity prices and also through compressed imports. This 'import compression,' can generate trade balance surpluses which can be used to service existing stock of foreign debt. Some frontier market countries, in contrast to broader market consensus, are likely to run a current account surplus such as Angola. Away from these, several middle eastern countries are also benefitting from this dynamic and some, such as Oman, are taking this opportunity to deleverage.
A potentially positive surprise in geopolitics
Geopolitics has dominated the emerging market landscape for several years now, including Russia’s invasion of Ukraine in 2022. However, our base case remains that Russia and Ukraine will come to a negotiated settlement sooner than the markets expect. Should our base case play out, energy prices are likely to soften, paving the way for moderation in global inflation, which will help cap the upside risk to the global rates complex. Asset prices in Ukraine would also receive a major lift given they trade at very depressed levels due to the high degree of market uncertainty over the duration and ultimate outcome of the war.
But there are headwinds out there…
We would be remiss if we did not mention prospective headwinds at play. One key question is the issue of funding of frontier countries, but, in our opinion, this concern is already priced in, to a large extent. Those countries that are stressed and likely to restructure, are well known to the market and asset prices are reflecting these difficulties. Another potential headwind could also be unexpectedly high volatility coming from US rates although our base case here is that US rates should remain rangebound at higher levels. Finally, the proactive approach taken by many emerging market central banks to raise rates early to head off inflation is dampening growth and presenting a headwind to the consumer in some countries, creating a more challenging environment for certain corporates that are more exposed to discretionary consumer trends.
Key takeaway
We continue to believe that emerging market debt, despite upcoming challenges, represents an attractive opportunity set within global markets, offering high yields and, in many instances, meaningful upside. Broadly speaking, we feel the emerging market investment opportunity is compelling and it is a case of when to invest in emerging markets, not if.
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