Emerging market debt: What a weaker China could mean

Emerging market debt expert Brett Diment joins Elizabeth on the podcast to recap the quarter that was before looking ahead at 2024. 

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Elizabeth Kaicher: Hello, everybody. I'm Elizabeth Kaicher from abrdn, and you're listening to the emerging market debt quarterly podcast show that looks at what happened during the recent quarter, and provides our outlook for the asset class going forward. Today, I'm joined by my colleague, Brett Diment, Head of Global emerging market debt. Brett, Happy New Year. And welcome to the podcast. It's really great to have you on

Brett Diment: Happy New Year Elizbeth. And yeah, great. Great to be on with you lots to talk about.

Elizabeth Kaicher: Yeah. So why don't we start by reviewing 2023 And a reminder of the key drivers of performance over the year and particularly that last quarter?

Brett Diment: Yeah, I mean, you know, generally 2023 Was it was a good year overall, for emerging market fixed income, particularly in the final quarter of the year, where we really saw some, some quite strong returns across the asset class. Just give you a sense of those, as I'm sure all our listeners are aware, emerging debt is a very broad asset class. So if we would start off looking at local currency denominated bonds, they were up 8% in the fourth quarter, just under 13%. For the year, US dollar denominated sovereign bonds. That's the NB 9% in the final quarter, 11% for the year, and corporate bonds, five and a half percent for the quarter 9% for the year. So a good enter the year, generally strong 2023 I guess, yeah. What were the drivers of that? First of all, you know, we think emerging fixed income started off the year and on the quarter, it really quite distressed levels. So a lot of lot of opportunity, a lot of value in the asset class. You know, generally, a more benign outlook core interest rates in the US in particular, was a positive for all fixed income markets, including emerging market debt. But some particular drivers within EM fixed income. So in local currency space, generally inflation, falling below expectations, particularly in Latin America, where we saw number, the big central banks, continuing to cut interest rates. If you look at the sovereign credit markets, then you've seen some of the lower rated credits really perform well, as he moved ahead with some of the debt restructurings in countries such as Ghana, or Zambia. And some of the credits that were distressed, but still performing having some quite positive news, Argentina really stand out there, but also names such as Pakistan, and in Tunisia. So, you know, some positive, broader drivers as well as positive drivers were in the asset class.

Elizabeth Kaicher: Yeah. And you could Can you talk a little bit more about inflation and the expectations for inflation? And how that will impact the asset class going into 2024?

Brett Diment: Yeah, sure. So, you know, I think, you know, one of the notable things about a number of emerging markets picking Latin America is that they were really quick off the mark and tightening interest rates, actually, during the pandemic, so you saw a number of the big central banks in Latin America really increase interest rates significantly, in the in the latter part of 2020. So that's, you know, two to two and a half years ahead of the major, you know, central developed markets, central banks, such as the Fed or the ECB. So, you've seen a very proactive monetary policy, and that has helped to bear down inflation, that really, you know, really bore out last year, we think, we think that's going to continue this year, or we think there are some, you know, some trends that started to develop in 2023. That will continue, and one I'd probably highlights on the inflation side is China. So China has now entered a period of deflation. So you actually have negative inflation on the headline level, inflation's minus 0.5%, year on year, and there's a number of structural factors driving that. Obviously, you know, you've got some quite big excess capacity in the manufacturing sector, downward pressure on the labor markets and continued downward pressure on the real estate market. So, you know, China will probably continue to have low inflation and that's, that's something that can be exported, and a deflationary factor for a lot of markets in the world.

Elizabeth Kaicher: So, Brett, how will the weaker China impact emerging market debt?

Brett Diment: Yeah, so, you know, as we touched on, I think on one level a weaker China is probably going to you know, help to keep a lid on demand for some commodities as such as such as the old price and obviously, you know, weaker oil price, generally will help keep inflation globally low. And also, if you look at a number that Yeah, the goods that China is exporting a lot of the goods in EVs or solar panels, for example, again, you know, they will perhaps contribute to global deflationary pressures. So we think, you know, we can the expected Chinese growth, you know, isn't necessarily a challenge for border EM, in terms of our portfolios. We are underweight, underweight China, really across local currency corporates and sovereign credit. So actually, it's been one of the relative contributors performance for emerging debt strategies over the past 12 months that China underweight

Elizabeth Kaicher: makes sense. And can you talk about a little bit about Latin America? How Latin rates contributed to performance in 2023? And then what your expectations for Latin going forward is?

Brett Diment: Yeah, so generally, you know, you know, Latin America, as you know, strong, strong performance at the, at the index level. So if you look at Brazil, for the year, Brazilian rial bonds in dollars, were up almost 30% 5% in the quarter, you know, generally, across our strategies, obviously, both for our kind of blended and local currency strategy, as we've generally been overweight, Latin American local currency debt. You know, we think that, you know, some of the some of the juices come out of the market, but still see some good value there. So if you look in Brazil, for example, here we have 10 year bond yields around 10 and a half percent, inflation is four and a half. So you still got quite attractive, you really yield 6%. Mexico, the peso did well, you know, this, this quite strong nearshoring story, really, really helping push foreign direct investment up in Mexico, we think that's going to kind of continue to be a theme. So, you know, that's a market where it's more a borrower currency play than a rights play, if you like.

Elizabeth Kaicher: And then our frontier exposure, I know a lot of emerging market debt investors are talking about frontier recently, we've historically focused on frontier and just talk a little bit about our, the impact of the performance, and then what the expectations again, are going forward and 2024.

Brett Diment: Yeah, yeah, I think I think you know, that the really important thing that people need to consider when they're looking at Frontier bonds is that it's all about picking the right credit. It's all about picking the right name. And yeah, last year was really a, you know, a very clear example of that. So you had, you know, even in the even in the fourth in the fourth quarter, you have some strong returns from the likes of China, zero 21%, Pakistan at 34%. But, but you also have some, some quite poor returns. So Bolivia was down was actually down 34% in the quarter. So asset selection is really key and frontier in that space. You know, we think there are some countries that still offer really, really strong opportunities. So names such as Nigeria, for example. And a Nigerian bond yield about 10%. In US dollars. Having a reformist president in Nigeria, moving towards liberalizing fuel prices will probably actually open up the FX market there. We think we have these kind of two large, sovereign debt restructurings, Ghana, and Zambia will think we make some progress there. So, you know, some opportunities, but also, you know, again, a space, you know, you need to really dig deep, if you like, in terms of the research. And, and that's, that's really a critical driver. We think that's a relative performance. And

Elizabeth Kaicher: I guess, finally, why is this a good time to allocate to emerging market debt? Brett?

Brett Diment: Yeah. So, you know, I think one thing about emerging debt is that you have really quite positive technical situation. And by that, I mean, looking at the supply demand dynamic in the corporate market will probably actually see debt repaid in corporate markets are given back to investors. Historically, the level of issuance in the sovereign markets in dollars in particular is going to be relatively low. We think it's an asset class that's really underrepresented in clients’ portfolios, particularly US dollar base clients. So you know, positioning we think it's favorable. We think even though you've seen some decline in in bond yields, and then that's part of the driver returns last year, you know, longer term, the valuation on emerging market currencies are really very attractive, particularly from $1 based investor perspective. So given the current of positive kind of current account situations, a lot of em we think, the scope, perhaps even for some nominal currency appreciation. And then, you know, I think I think finally, you know, in a world of inflation generally softening, you know, where the major central banks are Um, you know, that should be pretty positive for a high yielding asset class such as emerging market debt. But again, you know, it's really a question of being able to put your pick the spots in the space. But certainly, you know, we would argue some really, really interesting opportunities in end this year. But that

Elizabeth Kaicher: feels like a good place to bring this podcast to a close. Thank you, Brett, for joining us today. Great.

Brett Diment: Thank you. Thanks. Again, Happy New Year, everyone.

Elizabeth Kaicher: And thank you to everyone who took the time to listen in today. If you enjoyed what you heard, please download our other podcasts from our website or wherever you normally get your shows have a great day everyone.

This podcast is provided for general information only and assumes a certain level of knowledge of financial markets. It is provided for informational purposes only and should not be considered as an offer investment, recommendation or solicitation to deal in any of the investments or products mentioned herein and does not constitute investment research. The views in this podcast are those of the contributors at the time of publication and do not necessarily reflect those of Aberdeen. The companies discussed in this podcast have been selected for illustrative purposes only, or to demonstrate our investment management style and not as an investment recommendation or indication of their future performance. The value of investments and the income from them can go down as well as up and investors may get back less than the amount invested. Past performance is not a guide to future returns, return projections or estimates and provide no guarantee of future results.

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