HSBC GAM’s Osses sees Europe and US weighing on emerging markets

Uncertainty in Europe and the US is weighing heavily on emerging markets, says
Guillermo Osses, head of EMD portfolio management at HSBC Global Asset Management.

The past ten years have witnessed emerging markets put in place a variety of structures in a bid to boost national balance sheets, inflation and productivity. These efforts should continue to help maintain currency performance as well as credit quality, which boosts the case for emerging market debt (EMD) as a potentially attractive asset class long-term.

But of course, EMD has its own challenges and obstacles to tackle. Take the first quarter, when many investors increased allocations to EMD, all within an environment where liquidity between banks had been squeezed, as a result of rising regulation.

In addition, the much-maligned current account deficit in the US has actually decreased significantly over the past five years. In 2007, the deficit clocked in at close to 6% of GDP to presently 3.5% and this is a pattern we expect to continue as the US government tightens fiscal policy in 2013, which in turn should help the greenback. But the uncertainty in Europe coupled with the risk of fiscal tightening in the US, is likely to continue to weigh on risk assets next year.

What we foresee as a result of all these issues is that volatility in emerging market assets will probably increase at least relative to what we experienced in the first quarter of this year. We feel at the current juncture, the risk/reward proposition of external debt looks potentially more attractive than that of local currency denominated bonds.

In terms of external debt, with a yield of 5.71%, plus a roll-down of close to 150 bps per annum, it is currently not unreasonable to anticipate potential returns to be in the mid to high single digits over the next 12 months.

But this view has been obtained under the proviso that G3 central banks remain relatively accommodative, European policymakers manage to steady concern, and the US ­government eases into its fiscal adjustment in 2013. While this may not echo the market consensus, we believe there is a more than fair probability for all three of the conditions above materialising.

In terms of EM currencies, the short-term valuation indicators which we monitor point to a scenario whereby in late April this year, currencies had become somewhat overvalued. But since then, the EM currency index has corrected erasing a large part of this overvaluation.

EM bonds denominated in local currencies endure nearly double the volatility as those denominated in dollars and the lowering of the current account deficit in the US is likely to make it harder for currencies to appreciate against the dollar, the case for most of the past decade.  

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