Emerging market (EM) debt returned 0.5% (in US Dollar terms) in July reflecting income. The risk premium on EM debt increased over the month, with the spread on the index rising to 367 basis points (bps). The yield was virtually unchanged at 5.8%, while US 10-year Treasury yields rallied 18bps to 2.17%.

Market review

Emerging market (EM) debt returned 0.5% (in US Dollar terms) in July reflecting income. The risk premium on EM debt increased over the month, with the spread on the index rising to 367 basis points (bps). The yield was virtually unchanged at 5.8%, while US 10-year Treasury yields rallied 18bps to 2.17%. The US Treasury rally may have reflected some safe haven buying against a backdrop of plummeting commodities prices and concerns over China, where heavy selling in the stock market continued and economic data was disappointing.

Europe was the strongest performing region over the month as after three weeks of intensive negotiations, Greece secured yet another temporary financing solution that has meaningfully reduced the risk of exit from the euro zone, at least over the short-term. Ukraine was again the strongest performing credit as it continued to rally hard on expectations of a lower haircut for bondholders as part of a debt restructuring. The credit remains a significant underperformer over 12 months. Belarus outperformed on expectations it will receive a new loan from the IMF in return for the country agreeing to structural reforms, while Romania rallied due to the resolution in Greece.

Latin America underperformed overall. Brazil declined amid a raft of further negative news. Finance minister Levy announced this month that the fiscal targets which he had set for this year and next were no longer achievable. He revised the primary deficit target from 1.1% of GDP to 0.15% of GDP for 2015. The fiscal adjustment program has faced resistance in Congress, where some of the government’s measures were watered down or not approved. At the same time, tax revenue is plunging due to lower than anticipated growth. The political situation has also deteriorated further, with President Rousseff’s popularity reaching new lows and an increased risk of a break-up of the ruling coalition. S&P revised the ratings outlook for Brazil to negative after the government announced the reduction in the primary budget surplus targets. The rating agency believes that the political situation raises execution risks in relation to implementation of fiscal reforms.

On the other hand, Argentina did well, reversing some of the underperformance of the previous month. It is still too early to forecast the outcome of the upcoming presidential election in October, but investors are watching the campaign rhetoric of the candidates closely. In Turkey, political uncertainty remains high as well as the coalition talks between President Erdogan’s AKP and potential coalition partners have not yielded a result yet, leaving the possibility of new elections open.

More broadly, underperformers in July were dominated by oil credits, particularly Ecuador, Gabon and Azerbaijan, as the oil price plummeted. Commodity exporters such as Zambia and Mongolia also fared badly due to plunging commodities prices, though the latter has performed strongly in recent months.

Portfolio positioning

We participated in a number of new issues this month, in particular Jamaica and Zambia, which were attractively priced. The fund remains relatively cautiously positioned, as we anticipate further volatility in the run up to the September Fed meeting. The fund remains very selective in the less liquid credits such as the African ones.

Outlook

We anticipate bouts of market volatility in the run up to the first interest rate hike by the Fed. In EM, we expect continued differentiation between the economic and asset price performance of individual countries. Country selection will therefore remain an important driver of performance.

 

Source of country returns: JP Morgan, July 2015.

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