Emerging market debt: Momentum, Milei, and macro moves

In this latest episode, we explore the powerful forces shaping emerging market debt – from accelerating momentum and Argentina’s political shake-up to macro shifts driving investor flows.

Transcript

Paul Mohr: Hello and welcome to the Emerging Markets Quarterly Perspectives podcast. I'm Paul Mohr, Senior Director here at Aberdeen Investments. Each quarter we break down the key developments in emerging market. That and share our insights on what's ahead for the asset class. Today I'm joined by Siddharth Dahiya, our Global Head of Emerging Market Debt. So, welcome to the podcast. Great to have you on.

Siddharth Dahiya: Thanks, Paul. Thanks for having me. 

Paul: All right. Well, let's get started with, with where we usually start with, reviewing performance for the, the past quarter. Which is a strong one across the board. So, can you walk us through, how the various sectors of the market perform this quarter? 

Siddharth: Absolutely. Before we get into different sectors, let's to do a little recap of, how the Treasury market performed.

So, ten-year Treasury yield, fell below that first half, average. In, in this third quarter, as employment data kind of softened in the US and payroll numbers were revised downwards. Fed adopted a quite a dovish tone at Jackson Hole in followed through with with a rate cut in September.

We saw this in 2024. Yields bottomed around that meeting. And since then, towards the end of the quarter, they rose, moderately, despite this dovish shift, by the fed, the US dollar remained quite resilient against major currencies. Across the world. However, EM currencies sort of diverged against the dollar. Asian currencies generally weaken Latin American and African currencies posted strong gains.

And that supported local market returns in those countries. So, turning to, performance, local currency bonds, underperformed in Q3, but they still remained top performers year to date. Hard currency sovereign outperformed corporates within corporates. Returns were sort of similar between high yield and investment grade. Just to recap, local currency market returned around 2.5%, corporates just over 3%.

Sovereigns, in the high 4% range, for the quarter and frontier markets, not a 5%, in terms of spread, for the sovereign dollar market, the spread tightening by about 40 basis points. There's for the corporate dollar market, the spread, compressed by about 35 basis points. So clearly there was, there was strong, investor demand, and improving sentiment across, the EM space.

Paul: Let's, let's dive into the, the spread, topic there a little bit. You know, we're seeing historically tight spreads in both sovereign and corporate debt. What's underpinning those relatively tight spreads in the in the EM world? 

Siddharth: Yeah. Look, Paul, I think this is, an interesting point. You know, we've seen, tight spreads across the world.

For EM, I think this is a combination of, structural strength, within em and, a number of, maybe underappreciated tailwinds. Fundamentally and technically, em is in a very good space. You know, let's start with, let's start with local currency. So, for example, real yields in local currency historically, have hovered around, 1% range.

But after going deeply negative, over the last few years, they have rebounded very well above the average. And, now set closer to 3%, which is, I think, towards the higher end of the last ten years. So that's really attractive, right? We have talking about the undercurrents, across the market, especially the macro undercurrents.

We have seen this year, very strong. I led, euphoria in, in the US pockets of developed markets, particularly the US. But I think that is masking us, us a deeper, sort of reluctance to, to increase dollar exposure. Many we've seen inflows into, into US equities, but, perhaps, some of that inflow is, of a hedge nature.

We've seen that from, Dutch and Danish pension funds. They've, you know, they've increased their hedging ratio of their investments in the US. So, yeah. So clearly, investors across the world want to access the US corporate sector, but perhaps don't want to take increasing amount of dollar risk. That is a strong undercurrent which is clearly benefiting the EM market.

Both currencies as well as flows. The other strong structural support in Em is also, ratings. Right. EMEA countries went through a period of almost ten years where ratings, more ratings were downgraded and upgraded. So, on a net basis, you were seeing more downgrades and upgrades. Net negative. What we've seen in the last two years is that trend has changed, and now we are seeing that positive rating changes.

So, more upgrades than downgrades in the sovereign space. Just to give you an example, in the corporate space, in the quarter gone by in the third quarter, we had almost, more than $100 billion of bonds, which were upgraded just in the corporate, corporate hard currency space. We had about 20 odd billion dollars of bonds, which were downgraded.

So net upgrades very strong, about, $80 billion, by the way, this $100 billion of upgrade is the largest quarterly upgrade volume ever in the fund. We also see, very attractive spreads, to spread to risk ratio. So spread put leverage, which is our favorite metric when we look at the corporate world looks really attractive. Issuance has been high this year about $400 billion.

And I'm sure we'll talk more about this. But net issuance is still negative. So, more money coming back to them to to the investors than is taken away from them. Talking about frontier markets, the the growth differential of frontier countries, against the US has turned positive. Again. You know, historically this has been a key driver of performance and investor flows.

So, I would say across EM we are we are seeing across different markets, whether it is corporate sovereign frontier market, local markets, we are seeing real resilience, an improvement in fundamentals. Well, you know, since you mentioned the, the issuance topic, let's jump to that, and discuss that a little bit further. You know, we're seeing a resurgence in issuance this year, really since the beginning of the year.

Paul: But, you know, then in Q3, we saw large issues from from China and Brazil. How significant is that as an indicator of the broader investor interest in the asset class? 

Siddharth: Yeah, it's a very important point, Paul. So, EM issuance, hard currency bond issuance just to recap, in the third quarter was about $190 billion. This makes a new high for the third quarter, the sixth highest quarterly number on record off the 190, about 117 was from M corporates, about 73 was from sovereigns, right.

Year-to-date number is gross. Number is on almost $519 billion, which is higher than 2024. So that's a good sign and potentially going to end the year just under $700 billion, which would be the third highest annual figure. So just a, you know, just to give these numbers to us to say, look, issuance has been strong this year, which is a great indicator of interest in the market.

And EM world, by and large, what we see is that issuance dies down when investor sentiment towards M is not very strong. And when investor sentiment returns, we see, strong issuance coming back to the market. Now, the interesting thing that I said, earlier, the technicals are still very strong. So even though, of the close to $600 billion, about $400 billion is from corporate world, net issuance is still negative despite $400 billion of issuance, net issuance, which is basically how much money the companies give back to investors in the form of buybacks, tenders, amortization, all of those things still negative.

It is positive on the sovereign side. So, let's support the technicals. But nevertheless, overall market technicals are quite strong. So yeah absolutely. It's a case of issuance following demand. It's great. Well let's switch gears a little bit and talk more kind of the, the macro, the headlines, which you know, is often the case within emerging markets, there's, a range of headlines in the financial markets.

Paul: Throughout the past quarter, what were some of the ones that stood out to you as, as noteworthy or impactful for, for the asset class? 

Siddharth: Yeah. I mean, the tone of this podcast has been really positive. So, let's look at some of the negatives. Right. We, I'll give you to, to, events, which made quite a lot of headlines.

So, I'll take one from the sovereign space, one from the credit space, corporate space. On the sovereign space. Let's start with Argentina. Right. And president, Javier Milei, his, radical reforms, since he took power, this was called the shock therapy. In Argentina. It really got some progress. Initially, brought inflation down, delivered, a very rare budget surplus in Argentina for a number of months.

But by Q3 this year, the momentum started to fade a little bit. Political instability increased ahead of the October midterm election. So, there's a midterm election going to happen very soon in Argentina. And Milei’s parties, then came under pressure. Key fiscal reforms were overturned by the Congress. And then what happened was, as normally happens, in the center of the storm was, Karina Milei, the president's sister and the de facto Chief of Staff.

There was a leaked audio recording which kind of implicated her in a kickback scheme. And that triggered huge public outrage. Protest. A formal investigation. And Milei originally used to call these people, political elite. And now he finds his own inner circle under scrutiny. Right. The timing couldn't be worse. There was, the local election, the presence of this, I just had, election Milei’s party – La Libertad Avanza – they suffered a very resounding defeat.

And Buenos Aires is home to about 40% of the country's electorate. It's normally a bellwether, of future elections. Right. So that loss really rattled the market. The peso dropped a lot. Investor confidence took a huge hit in Argentina. We had a very sharp selloff in all Argentine assets. There was, again, a renewed fear of default in Argentina.

In response, though, and people might have picked up in couple of press, the US stepped in, and showed, $20 billion liquidity backstop that did, temporarily stabilize the market. But again, I mean, Argentina remains vulnerable. There is an election in 30 weeks. They have depleted reserves. They've never really let the currency float.

And the confidence is lacking at the moment. In in the policy direction of the country. So that's, on the sovereign space. In the corporate space again, slightly negative story, which had some impact towards the end of this quarter, of Q3 rather, and beginning of Q4 so far. So, a company, a Brazilian company called Braskem, which is one of the largest petrochemical companies in in Latin America, has had some shareholder issues.

One of their shareholders is in wanting to sell their stake, but the stake is pledged to different banks and they can't get around that. That company is going through, a shareholder issue, plus, a big dip in petrochemical prices. Petrochemicals industry is going through a prolonged down cycle, which is impacting the results of this company. Leverage has shot up, and earnings have been very weak of the free cash flow being negative for a number of quarters towards the end of third quarter.

Somewhat of a surprise to the market, the company announced that they had hired advisors, for looking at the cap structure, which, in simple English means that they want to restructure their bonds and that really rattled the market. And it rattled other, other parts of EM credit universe as well. So, in sympathy, there were a number of names in Brazil, Latin America which, had and and Robin.

So that story is developing. We will see, shortly how that story develops. But, I mean, I'm sure it's going to continue for the next few quarters, and it's, its large cap name, which does have impact on overall sentiment in the end. So, yeah, there's lots of other things, but two things that come to mind.

Yeah, there's never a dull moment in emerging markets for sure from a, from a headline perspective. But we are contractually obligated to end on a positive note. 

Paul: So, we're going to switch gears again, then to, to the asset raising perspective. So where have you seen the most traction, recently? And where do you expect investor interest to be concentrated over the coming, the coming months?

Siddharth: Yeah, Paul, I think this is been one of those rare years in the, where you are seeing positive tailwinds behind all different parts of em, and you're seeing interest across the broad swathes of fiat. Right? So, we have seen an increase in RFP activity this year. We have seen quite a lot of interest in our open-ended funds.

So, you know, our, frontier strategies, the corporate strategies, they've had significant, inflows, this year, we've had, we've had a number of, separate card segregated accounts being funded this year, predominantly blended accounts. And actually, one of the more interesting developments is that we're seeing, more and more of our clients, discussing or venturing into, the, the newer frontiers of, of emerging markets, which is where we are.

We've been putting a lot of but, these, this is sort of on the border of the public private space. We have a new client which allows us to who allows us to to have, a certain amount of their investment in loans and private placements. And we're really excited, for that private credit in the AMA.

Paul: It sounds like, a topic we have to dive into deeper on, on a future episode, for sure. But with that, I think that feels like a good place to bring this episode. To a close. Said, thank you so much for joining us today again and really appreciate it. Great. Thank you for and thank you to everyone who took the time to listen in today.

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