BlueOrchard Brief: Positive outlook for Emerging Market bonds offers opportunities

18/10/2021 Blog

Emerging and developing economies have repeatedly demonstrated their resilience despite recurrent Covid-19 infections and emerging inflation concerns. However, thoughtful intervention by central banks to manage inflation, and rising vaccination rates, could contribute to a relatively swift economic recovery in these countries. Read below a commentary by Michael Wehrle, Head of Investment Solutions at BlueOrchard, on why he currently sees more opportunities in impact and green bonds in emerging and developing markets than in developed markets.

 „Over the first half of the year, bond market volatility was predominantly driven by the rise in US Treasury yields and rising inflation, whereas credit spread volatility was lower. Accordingly, the average spread for BBB-rated Emerging Market bonds was relatively narrow – ranging from 185 to 210 basis points. On the contrary, interest rates for US government bonds increased significantly. Bond portfolio performance was therefore driven by duration risk rather than credit risk.

According to the IMF, global economic growth is forecast at six percent in 2021 and 4.9 percent in 2022[1]. The global economy has recovered rapidly in the first half of 2021. Nevertheless, Covid-19 infections in certain countries in emerging and developing markets may mean that steps towards normalisation and full recovery will vary between countries. However, developments over the past six months have shown that both industrialised as well as emerging and developing countries can recover again despite a significant wave of infections. This resilience and rising vaccination rates support the positive outlook for emerging and developing countries. For example, countries such as India, which was particularly affected by the 2nd wave of the pandemic from a health perspective, should continue to recover due to the expected less severe constraints on the economy in the second half of the year and thanks to targeted structural measures by the central bank and government.

Currently, central banks tend to accept a certain level of inflation in order not to jeopardise the economic recovery. Therefore, we consider a moderate increase in the steepness of the yield curve and a higher level of inflation as likely. In Emerging Markets, we note that some central banks are already reacting more aggressively to inflation concerns and are raising interest rates faster with the risk of slowing the economic recovery. This is the case in Brazil, Russia and Hungary, for example. However, as we see it, the market is aware of this risk. Clear communication from central banks about their monetary policy will generally be crucial.

Despite the risks to the global economy from the Covid-19 Delta variant, the constraints and partial imbalance between supply and demand in global supply chains, as well as the potential for interest rate increases, we remain optimistic about the global recovery. In our Impact and Green Bond Portfolios, we generally see more opportunities in Emerging Market bonds than in developed market bonds.

Within Emerging Markets and developing countries, we prefer bonds with higher yields due to their lower interest rate sensitivity. We have a particular focus on countries and sectors that are not overly dependent on the exceptional liquidity situation in the financial markets, such as Chile or certain countries in Eastern Europe. We also prefer securities whose valuation is based primarily on uncorrelated idiosyncratic risks. A careful selection of bonds and a diversification of the portfolio within the growing universe of impact, social and green bonds are, however, still important to manage existing risks.“

[1] World Economic Outlook H2 2021 by the International Monetary Fund, July 2021

 

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