**Emerging Markets Debt: Q3 2024 Review and Outlook**
The third quarter of 2024 saw a rebound in emerging markets debt, driven primarily by movements in US interest rates. As US inflation cooled and the labor market slowed, the 10-year US Treasury yield fell by approximately 80bps, prompting a 50bps rate cut by the Fed in September. This decline led to a weakening of the US dollar, a steepening of the yield curve, tightening of credit spreads, and a rally in risk assets, particularly emerging markets debt.
Local debt led the emerging markets rally in Q3, with emerging markets currencies strengthening against a weakening US dollar. However, on a year-to-date basis, local debt continues to lag hard currency sovereign and corporate debt, which have benefited from favorable changes in US interest rates throughout the year.
The Fed’s September decision to cut interest rates marks a convergence among developed world central banks. In Q3, several central banks implemented rate cuts, while others, like the Bank of Japan, raised interest rates, setting off a global unwinding of the popular yen carry trade.
Emerging markets central banks are increasingly aligning their monetary policies to developed market policy, presenting differentiated opportunities. Several central banks cut rates during Q3, while others, like Nigeria, raised rates. Brazil reversed its monetary policy direction in September, raising rates by 0.25% after cutting them in the previous seven meetings.
The high yield segment of the sovereign market experienced volatility, particularly in early August, as fears of a hard landing resurfaced. However, credit spreads tightened almost as quickly as they widened, and Fed Chair Powell’s dovish speech at Jackson Hole helped stabilize markets.
The US dollar weakened throughout Q3, contributing to a broad strengthening of emerging markets currencies and lifting emerging markets local bonds. Several Asian currencies, including the Malaysian ringgit, Thai baht, Indonesian rupiah, and Japanese yen, were among the top performers for the quarter.
Local events across the globe continue to shape idiosyncratic returns. Venezuelan sovereign bonds declined following the August presidential elections, while Argentina’s fiscal consolidation boosted its sovereign bonds throughout Q3. Ukrainian sovereign bonds rallied after the country reached an agreement with creditors on its debt restructuring.
The portfolio remains conservatively positioned as geopolitical uncertainty persists. However, the team capitalized on opportunities across various risk factors as they arose. The portfolio remains overweight duration in emerging markets and underweight duration in developed markets relative to the J.P. Morgan EMB Hard Currency/Local Currency 50/50 Index, translating to an overall underweight duration positioning relative to the index.
The team reduced the portfolio’s currency exposure but remains overweight relative to the index, with a focus on Asian currencies where strong growth prospects and restrictive monetary policies kept currency valuations attractive. Sovereign credit positioning was flat during Q3 and remains overweight compared to the index.
The EMsights Capital Group continues to search for countries with improving storylines where market prices are not fully reflecting fundamentals. The team seeks out idiosyncratic events in the corporate and sovereign space that shape the market landscape and drive divergence between regions and countries.
The global economy continues to face challenges, many of which are serving as tailwinds that keep the emerging markets debt outlook strong. With one of the busiest election cycles on record, growing geopolitical tensions, and fiscal consolidation, the team remains focused on exploiting volatility events and seeking opportunities in the emerging markets debt space.
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