Bonds that entice

STRONG private consumption, investment, exports and resilient economic growth are likely to make emerging market (EM) bonds attractive for the remainder of 2024.

Normalising inflation should also support further monetary policy easing in EM, says BNP Paribas Asset Management.

“Finally, money continues to flow into EM hard currency external bonds, local currency denominated bonds, and corporate bonds, while the supply of these bonds remains below pre-pandemic levels,” the investment management group states in a recent report to clients.

However, it concedes that volatility may persist because of US political uncertainties, commodity prices responding to geopolitical concerns, and uncertainty about the pace of economic growth in China.

“As we do not expect any of these factors to fundamentally derail EM economies or bond markets, they may create compelling opportunities to adjust exposure.

“The current combination of positive fundamental and technical factors supports staying invested in EM bonds, enjoying the relatively higher yields,” BNP Paribas says.

The beginning of a US Federal Reserve (Fed) rate cutting cycle has typically not supported strong returns in EM bonds.

However, previous rate cutting cycles have usually been accompanied by recessions and little demand for higher-yielding assets. This cycle, though, has robust growth and strong demand, BNP Paribas says.

“Additionally, the same history shows that EM local-currency denominated bond yields are more likely to follow the Fed, falling in yield and rising in price,” it points out.

“Furthermore, EM local-currency bond yields rose significantly in recent years and their real (adjusted for inflation expectations) yields are now at historically attractive levels, particularly relative to real yields in the United States,” it adds.

According to BNP Paribas, the combination of renewed economic growth, stable inflation, lower interest rates and attractive valuations suggest that the asset class could provide compelling returns over both the short and medium term.

“Country selection is important, however, as some regions or individual countries are further along in their monetary easing cycle than others. Some have yet to start,” it argues.

The group expects Latin America will remain a leader in lowering rates, driven by Colombia, Chile and Peru.

In Eastern Europe, Hungary, Czechia and Romania are likely to lead in cutting rates, while countries like Turkiye and Egypt seem to be on the path to achieving a level of stability that could allow lower interest rates in the quarters ahead.

EM corporate bond spreads have compressed in recent quarters and thus some countries and or sectors have begun to look expensive on an absolute basis, BNP Paribas notes.

However, it points out that relative to their counterparts in the United States or other developed markets, EM corporate bonds remain attractive.

“EM investment-grade corporates currently offer yields of more than 30 basis points (bps) higher than their developed market equivalents, while sub-investment grade (high yield) EM corporates offer yields closer to 70bps greater than their developed market equivalents,” BNP Paribas says.

Overall, EM corporate fundamentals remain strong, with recent earnings reports generally supporting a resilient outlook.

While geopolitical tensions like the conflict in the Red Sea have introduced potential supply chain disruptions, EM corporates have demonstrated agility in their operations by adapting suppliers or optimising cost structures to mitigate impacts, it points out.Additionally, it anticipates a favourable technical environment persisting at least through the end of 2024.

“The supply of corporate bonds has picked up recently but remains much lower than before the pandemic. We expect this more moderate level of bond supply at least through the end of 2024,” BNP Paribas says.

Selective in sovereigns

Meanwhile, BNP Paribas maintains its “positive” outlook for EM hard-currency sovereign bonds, supported by improving fundamentals, lower developed market interest rates, and consistent demand for the bonds’ relatively high yields.

However, it continues to expect performance to remain somewhat diverse.

For example, it highlights idiosyncratic situations like the ongoing debt restructuring in Ukraine and Sri Lanka, as well as challenges faced by frontier markets such as Egypt and other African sovereigns, which could stand to benefit from stronger economic growth and sustained demand for the higher yields they offer.

China has recently broadened and deepened its attempts to revitalise the country’s economy.

While it is too early to estimate how successful these measures will be or predict how much more stimulus the government will provide, success could significantly improve the outlook for regional EM economies, BNP Paribas argues.“China’s own challenges remain and are significant to the world economy. Growth targets will remain the primary focus into 2025, as local property market woes weigh on economic activity,” it says.

“If current or forthcoming measures are more pronounced, we could see positive growth sooner, providing further support for global emerging market bonds,” it adds.

It is worth noting that EM has endured several national elections in 2024, notably in South Africa, India, Indonesia, and Mexico, that created pockets of opportunity.

While some caution is warranted, with significant events ahead, BNP Paribas holds to the view that investors are better served focusing on fundamental factors that drive markets over the long term.

The fundamental outlook for EM sovereign and corporate bonds remains positive, while current yields offer compelling compensation for the current uncertainties.