Have you raised your allocation to emerging market bonds? If not, what would be the catalyst for you to do so?
We believe that 2023 will be a good year for fixed income, with bonds expected to outperform as recessionary risks increase. Within fixed income, we favour investment grade credit, particularly US and Euro credit based on strong fundamentals and high yields and spreads, leaving room for spread compression.
We also like emerging market (EM) bonds, both in local currency and US dollar-denominated. We prefer commodity exporters and high-quality issuers, and expect that the resumption of activity in China will support EM assets in general.
Among EM bonds, we are particularly positive on Indonesia. We expect Indonesia’s economy to gain momentum on further reopening and the government to follow through on reforms and infrastructure projects. As China continues to reopen, we expect strong commodity demand to support the Indonesian rupiah. Apart from the sovereign, we also remain comfortable with Indonesian state-owned enterprises in the infrastructure space.
Finally, with China ending its zero-Covid policy and having supportive policies for the property sector and encouragement for foreign investment, we are now also starting to turn more constructive on China.
Have you raised your allocation to emerging market bonds? If not, what would be the catalyst for you to do so?
Our preferred allocation in EM debt is to EM local currency bonds. EM local currency debt provides investors with non-US dollar foreign exchange (FX) exposure as the US dollar bear market looks set to resume. Providing a modest premium to US government bonds, a pause in the Fed hiking cycle, which we expect later this year, should provide a catalyst for strengthening EM FX rates against the US dollar and provide portfolios with an alternative source of return beyond the high volatility we are seeing in the wider US dollar bond market currently.
In contrast to this ‘FX carry’ opportunity from EM local currency bonds, EM US dollar investment grade exposure offers limited pickup versus broader US dollar investment grade yields. Although EM high yield bonds offer a cyclically large premium to US high yield bonds, the exposure to the ongoing restructuring of the Chinese property sector suggests caution is warranted for global investors.
