NN IP sees support for hard currency emerging market debt

The technical picture in hard currency (HC) emerging market debt (EMD) has a strong positive bias, according to according to NN Investment Partners. The specialist investment house sees substantial year-to-date inflows and limited net issuance in the near term.

NN IP says it continues to see the green shoots of more stable fundamentals in EMs, partially helped by stable commodity prices, especially oil but also industrial metals. In some countries even improving, it observes.

In particular, the fundamentals of corporate debt have been improving and NN IP points to an encouraging upturn in the upgrade/downgrade ratio. Valuations still offer value compared to other corporate credit asset classes, it believes.

First quarter positive

• The first quarter of 2017 was a positive one for the asset class
• Strong performances were recorded across the board
• Both HC and local currency (LC) strategies enjoyed continued inflows
• NN IP expects this will continue this year

NN IP notes however that the improvement in fundamentals for EMD HC has to be balanced against valuations that are closer to fair and a potential increase in risk from US policies under President Trump.

Marco Ruijer, lead portfolio manager, EMD hard currency (pictured below), said leading indicators point to a modest acceleration of global economic dynamics. The combination of growth and benign inflation should not be disruptive for fixed income in the near term.

Economic growth stabilised

Importantly, economic growth in EM economies has stabilised amid relatively high real interest rates, undervalued currencies and stable to improving commodity prices, he believes. This should offer the asset class a better balance against potential headwinds.

The market has more confidence in the outlook given the improvements in global growth as compared to the disruptive period around the so-called ‘taper tantrum’ when the US/EM growth rates were converging in opposite directions, he adds.

If US data continue to be somewhat mixed then it could further extend the Goldilocks period in which policy remains expansionary with little impulse. This will give the Fed the opportunity to begin reducing the size of its balance sheet, he goes on.

China growth momentum to remain robust

• China’s growth momentum will remain robust
• Latest indicators suggest growth momentum has continued into 2017
• Accommodative policy stance still required to stabilize the economy
• This would be a key anchor EM as a whole
• China government likely to show resolve to maintain steady exchange rate
• This to achieved this by using reserves, regulating capital outflows and opening up domestic market

All braced for Fed hike

Elsewhere, expectations are pretty much set in concrete for an increase in interest rates in the USA. Dave Chappell, fixed income portfolio manager at Columbia Threadneedle Investments, expects the Federal Reserve to deliver a 25 basis points hike tomorrow.

Accompanying the hike, forecasts for both inflation and the unemployment rate may be marked lower, while growth forecasts will likely remain unchanged. In terms of the median ‘dots’ profile, he says he does not expect any surprises either way.

By delivering two hikes in the first half of the year, (ahead of Columbia Threadneedle expectations), the Fed will have bought itself some flexibility around the delivery of further normalisation of policy, he says.

David Chappell, Columbia Threadneedle

Eager to reduce balance sheet

The most recent FOMC (Federal Open Market Committee) minutes clearly stated that the committee is eager to begin a slow reduction of its balance sheet, via a tapering of reinvestment of maturing treasuries and mortgage-backed securities, he notes.

“It may feel it is necessary to introduce this programme separately from another increase in the funds rate. The announcement could occur in September or December, assuming the economy and markets continue to perform as expected.”

He says he does not believe the inflation profile warrants the three hikes forecast for this year. “We look for the post-Trump bounce in sentiment, both at the business and consumer level to converge with actual activity readings over the coming months,” he concludes.