EMD Outlook: In the Eye of the Storm

At the start of 2022, emerging economies were already facing a challenging backdrop: high EM and global inflation along with looming policy reversal including quantitative tightening (QT) by major developed market (DM) central banks — and the US Federal Reserve in particular — were expected to have a negative impact on the performance of EM bonds. Exacerbating these has been Russia’s invasion of Ukraine — what had been widely viewed as a tail risk at the beginning of the year has unfortunately materialised, and once again emerging markets are caught in the eye of the storm. What is different this time is that the Russia-Ukraine War is having far broader implications beyond the countries directly affected by it. As well as having a dramatic impact on Russian and Ukrainian assets, the war’s impact has spilled over into neighbouring countries and those with strong trading ties are particularly affected – the reliance on Russian energy has been a notable factor. But this is an event that has also had a global impact with prices of commodities surging: energy prices have driven sharply higher but agricultural commodities such as wheat and fertiliser have also experienced a significant increase, further raising concerns for the health of the global economy. The outlook for EM remains uncertain as it is closely tied to the evolution and outcome of the Russia-Ukraine War, which is having a wide-ranging impact on global markets, rather than just the countries directly involved. The net effect has been higher inflation and lower growth with further havoc in commodity markets still possible. This is adding further fuel to inflation and applying downside pressure on growth. Intensifying macro headwinds and geopolitical risk have stifled demand for EM debt, but even in the midst of this perfect storm there are some silver linings for the asset class. Both EMD LC and HC offer better value than they have for some time. For investors willing to live with short-term volatility, this could prove to be a good entry point into the asset class. Moreover, yields at an index level for both EMD LC and HC are at their highest levels in a decade, making the asset class a highly attractive option for return-seeking investors.