Emerging bond markets have enjoyed a strong rally since the sharp drawdown experienced in the teeth of the COVID crisis last year. As a result, valuations have recovered significantly even as some of the fundamentals have deteriorated — most notably on the fiscal and debt sustainability side. And while the start of 2021 has shown that smooth sailing cannot be guaranteed, there are reasons for cautious optimism.
Following the robust recovery and taking account of recent developments, it is not unreasonable that investors might question whether there is still space for emerging market debt (EMD) to advance further. The post-COVID rally has seen a strong recovery from the lows, but we still see reasons to remain constructive on the asset class. While the macro backdrop has been changing, it is still largely supportive for EM Debt. Combined with the global hunt for yield, this is likely to continue to drive flows into the asset class and thereby support performance.
The EM debt advance continued following the US elections in November and the approval of COVID vaccines. Indeed, in the last two months of 2020, buoyant markets saw the riskier parts of the asset class outperform. In hard currency (HC) EMD, high yield issuers which had lagged in the initial rebound drove this leg of the rally, while local currency EMD was bolstered by recovery in EM currencies. Although the start of 2021 has brought volatility to EMD due to the rapid rise in US Treasury yields, this has been due to expectations for even stronger US growth; despite these short-term jitters, strong US and global growth is supportive of risk assets like EM debt.