Anticipating a recovery in emerging markets

Marcelo Assalin, head of Emerging Market Debt and Lead Portfolio Manager EMD Blended Strategies at NN Investment Partners

2015 was a relatively tough year for emerging markets (EM) and the emerging market debt (EMD) asset class. Especially the sharp depreciation of EM currencies relative to the US dollar affected returns.

Despite all the negative headlines, hard currency (HC) bonds, both sovereign and corporate, managed to realise a small positive return.

The challenging environment for EM is likely to stay with us for some months to come. Commodity and oil prices may remain under pressure, weighing on EM currencies and investor flows and sentiment.

However, somewhere in the second quarter the oil price may start to recover somewhat, as some improvement in the supply/demand balance should become visible.

Combined with a better visibility on the Federal Reserve’s monetary policy outlook this might lay the foundation for a tentative recovery in EMD.

We also expect additional monetary and fiscal stimulus from China, which would be supportive to EM assets in general.

Moreover, I think that a benign inflationary backdrop will allow for accommodative monetary policies to remain in place in a number of EM countries.

That should be positive for growth as well. I do not expect EM growth to recover already this year, that will be more of a 2017 story.

But, as markets are always anticipating, they could already start pricing in a recovery from the second half of this year onwards.

Risks keep surrounding the EM universe
Prolonged weakness in commodities, a stronger than expected Chinese growth slowdown, a disorderly Chinese currency depreciation, weaker than expected growth in the US, policy mistakes by the Fed and unexpected large corporate defaults are the main risks in my opinion.

As we have seen in the first week of the year, markets are still concerned about China. I think this is a bit overdone.

The direction of the yuan should become more predictable in the coming months. Some gradual depreciation against the US dollar is to be expected as China’s monetary policy stance diverges from the US.

But China is not about to embark on a currency war to stimulate its exports, as the move would not fit its policy of transforming the economy to a more consumption and services-based one, from an investment and export-led model.

Growth will also keep slowing down, to still very healthy levels though, which is part of the economy becoming more mature.

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