Emerging Market Debt Commentary: July 2022

Emerging market debt benefited from some softening of US rate hike expectations amid weaker economic growth data, although returns typically lagged developed market bonds. Sustained US dollar strength also weighed on local currency EM debt in the month.

Emerging Market Debt (in USD terms) recorded modestly positive returns in July as concerns around weaker growth data from the United States and elsewhere, as well as indications that future US Federal Reserve moves were to be more data dependent, were interpreted by markets as dovish. This allowed for a slight easing in financial conditions and an improvement in risk sentiment globally. However, EM remains vulnerable to recession risk from the euro area, geopolitical concerns and sporadic rolling lockdowns in China. During July 2022, hard currency outflows were -$3.1bn, while local currency outflows amounted to -$3.4bn. (Source: JP Morgan)

EM local currency debt returned +0.29% in US dollar terms in July 2022, as measured by the JP Morgan GBI-EM Global Diversified Index. This was mostly driven by negative foreign exchange (FX) returns (-1.35%), which is largely attributable to the continued strength of the dollar. The negative FX return was offset by positive price (+1.21%) and interest (+0.44%) returns. Growth risk had come to the forefront in EM economies during July as a result of the monetary tightening that had taken place already, resulting in a rally in their local currency bond markets on speculation that central banks could slow the pace rate hikes.

EM hard currency sovereign debt returned 2.89% in July 2022, as measured by the JP Morgan EMBI Global Diversified Index, driven by positive returns from both spread (0.73%) and treasury (2.15%) components. A relief rally was observed in US Treasuries due to a dovish interpretation of the latest meeting of the Federal Open Market Committee (FOMC). One-year forward rate expectations for the US have retreated more than 100bps from their peak in the space of a month, allowing for a slight easing in financial market conditions and underpinning a tightening in hard currency spreads.