Key Takeaways
Emerging market (EM) performance has held up well against a volatile global market backdrop, with local currency bonds a highlight
This year, the main source of EM risk has been exogenous to the asset class. With US Treasury yields under pressure, could a sustained rise in the long end of the curve usher in a broad-based risk-off environment?
While monitoring this risk, we think some of our key EM investment themes remain valid, with opportunities available in EM local currency bonds and selected EM countries on a reform path.
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Over the last two months – from “Liberation Day” on 2 April to 27 May – emerging markets (EM) have been on a circular journey. At 331 basis points, EM sovereign hard currency spreads have tightened to where they were before US President Donald Trump’s announcement of broad-based tariffs on virtually all his nation’s trading partners. The main reversal came following news on 12 May of a temporary cut in tariffs between the US and China. This soothed market concerns over the impact of a trade war. Despite some lingering uncertainty on what will happen after the 90-day pause in US-China tariffs, fears of a US recession have abated, with most analysts expecting subdued but positive US growth this year.
This turn in the American economic outlook and market sentiment proved supportive for EM in the immediate aftermath of the tariff de-escalation news. The JP Morgan-EMBIGD index has delivered +1.9% year to date and the high yield (HY) segment +2.3% year to date. However, since then, market focus has shifted to the impact of the upcoming US tax and budget bills. While, on balance, lower taxes should boost US growth prospects, concerns are rising that the budget deficit would increase in coming years at a time when investor appetite for US assets is being tested across the globe. Nowhere are these concerns more clearly reflected than in the US Treasury curve, where 30-year yields have broken through 5%.