By Alejandro Arevalo
Fund manager of Jupiter Global Emerging Markets Corporate Bond SICAV & Jupiter Global Emerging Markets Short Duration Bond SICAV
As we head into 2018, emerging market debt is likely to continue to benefit from improving macroeconomic conditions. Some countries, however, face heightened political and policy risk, as well tightening spreads. In a year that may see increased volatility, we believe it is important to capitalise on the idiosyncrasies within emerging markets to generate alpha.
Emerging market economies greatly benefited from the synchronized global recovery in 2017, and we expect this strong growth to continue into 2018. With inflation numbers in most developed economies remaining low and expectations well-anchored, we anticipate a dovish approach from central banks that will continue to provide support to emerging economies. Against this backdrop, we expect the gap between emerging markets (“EM”) and developed markets (“DM”) growth to continue to widen.
With several EM countries in the process of structural reforms, a heavy 2018 election calendar, notably in Latin America, could drive market sentiment in the run up to key election dates
Macroeconomic fundamentals have vastly improved since the infamous “taper tantrum” of 2013. While not all EM economies have moved in the same direction, there have been enough improvements to make the asset class more resilient to external shocks. Current account deficits in 2018 should be less of a concern, as these have improved across the board, particularly in the infamous “Fragile Five” economies (India, Brazil, Turkey, South Africa and Indonesia). Headline inflation has likely bottomed out for many countries, in our view, and we expect it to return to below central bank targets. Meanwhile, lower interest rates should create a more supportive environment for businesses.
While the macroeconomic backdrop is strong, there are several risks that we are closely monitoring. First, with several EM countries in the process of structural reforms, a heavy 2018 election calendar, notably in Latin America, could drive market sentiment in the run up to key election dates.
Secondly, Federal Reserve policymakers forecast four interest rate rises over 2018. While we don’t expect this to pose significant headwinds for the asset class, we need to be vigilant for further flattening of the yield curve. We expect a modest tightening of spreads next year as we believe EM economies will continue to benefit from better fundamentals and attractive relative valuations.
Heading into 2018, we are most constructive on the outlook for Latin America. That said, we are conscious of the risks, given the many uncertainties facing the region next year i.e. NAFTA, elections (most notably in Brazil, Mexico and Colombia), and uncertainty about the planned debt restructuring in Venezuela. We do think, however, that company fundamentals will continue to improve, driven by higher regional growth, stable, and potentially also higher, commodity prices and limited defaults. Overall, we believe Latin America provides an attractive risk-reward payoff compared to other EM and DM economies.
We see opportunities in some Turkish banks and corporates that we view as fundamentally stable. However, we are cautious about risks surrounding the ongoing court cases in the US and monetary policy uncertainty.
After Russia’s stellar returns in 2015 and 2016, valuations have tightened significantly. Nevertheless, Russia still fulfils two of the criteria we like from a macroeconomic perspective: stable domestic politics and credible monetary policy. It is unlikely that the economic trajectory will change. Therefore, we favour carry trades in stable company debt in Russia.
Turkey is a country whose external vulnerability is evident from its sensitivity to sometimes-irrelevant headlines. We see opportunities in some Turkish banks and corporates that we view as fundamentally stable. However, we are cautious about risks surrounding the ongoing court cases in the US and monetary policy uncertainty.
Finally, Ukrainian bonds have performed very well in 2017, helped by the continuity of the IMF programme which has underpinned the gradual recovery of the economy. However, there are still a plethora of reforms on the agenda between the EU and Ukraine, and it is uncertain how many of these can be delivered. Nevertheless, Ukraine’s current reserve balance is sufficient to cover the debt maturities in 2018, and as a result, we view shorter duration corporate and sovereign bonds as more attractive.