Investors in EM Bonds Uneasily Await the Outcome of the U.S. Election
Emerging market bonds issued in dollars have more than held their own as global fixed income sold off over the past month. Local-currency bonds, not so much. Now comes the U.S. election.
Emerging markets have shifted massively toward issuing debt in their own currencies since a series of crises in the 1980s and ’90s. That makes them more stable but leaves $7 trillion or so in bonds extremely vulnerable to the electoral outcome on Nov. 5.
Donald Trump’s promised 10% tariffs on all imports to the U.S. would push exporting countries to weaken their currencies in response. Even the threat could crater bonds priced in those currencies. “Trump would use very hawkish rhetoric over the next few months,” says Arthur Budaghyan, chief emerging markets strategist at BCA Research.
That still leaves more than $1 trillion in emerging market debt issued in dollars, though. Spreads for this subasset class over U.S. Treasuries, investors’ key guidepost, tightened by 0.23%, or 23 basis points, during October, says Cem Karacadag, head of emerging markets sovereign debt at Barings.
Riskier credits outperformed. High-yield sovereigns tightened by 50 basis points as investors gained confidence in the solvency of onetime basket cases such as Argentina, Pakistan, and Sri Lanka.
That reflects markets’ view that “fundamentals are pretty good,” says David Robbins, group managing director for emerging markets at fixed-income specialist TCW. Both the U.S. and Europe still look to be headed for “soft landings,” enabling central banks to cut interest rates even as economies keep growing.
China may perk up as Beijing steps on the stimulus gas. Prices for oil, which most emerging markets import, are dipping again after a blip in early October on Middle East tensions. The more spreads tighten, the harder it is to find value in emerging market bonds. “The bulk of the bull run has happened,” Robbins says.
Investment-grade issuers leave little further upside, Karacadag thinks. “If you’re buying Saudi Arabia, Indonesia, or the Philippines, that’s basically a U.S. Treasury with a little spread on top,” he says.
He is trawling for appreciation in Central American and Caribbean countries including Costa Rica, Guatemala, and the Dominican Republic. They benefit from U.S. economic buoyancy through tourism and remittances without the political complexities of Mexico, he argues.
Robbins favors debt from Turkey and Egypt, where economic policy is improving and regional stress possibly receding. He also likes West African oil producers Angola and Gabon.
Kamakshya Trivedi, head of global FX and emerging markets strategy research at Goldman Sachs, sees value in South Africa, where a new coalition government is “addressing fiscal concerns in a fairly credible fashion.” He’s also bullish on paper from Czechia (the Czech Republic), Hungary, and Poland, whose interest rates may drop to converge with the euro zone.
In sum, “idiosyncratic” is the word of the moment.
A Kamala Harris victory might spur a relief rally in local-currency emerging markets debt. But it would leave a central challenge in place: U.S. economic outperformance that pushes the Federal Reserve, and the dollar, to stay higher for longer. “What’s most important for EM debt is a more balanced global growth picture,” Trivedi says. “China and Europe doing better takes the edge off the dollar.”
One way or another, investors should let some dust settle before making any dramatic moves, says Cathy Hepworth, head of emerging markets debt at PGIM Fixed Income. “It is too early to meaningfully add risk,” she says.