Short duration emerging market bonds look attractive, as the threat of a rise in US interest rates looms large, writes Damien Buchet, head of emerging market debt at AXA IM.
Since the change of tack at the Federal Reserve in May, emerging markets have faced significant outflows of around $50bn from both equity and fixed income investors.
A number of things can explain this, including better opportunities in developed markets, fears of a Chinese slowdown and social unrest in several countries throughout June (Brazil, Turkey, Bulgaria and Egypt, for example).
While we believe current account deterioration and the associated funding issues do exist, it mostly affects five countries (India, Indonesia, Brazil, Turkey and South Africa) whose currencies have depreciated by between 10% and 15% since early May.
The only way is up
But the issues for these challenged countries are mostly a problem of income statement, not of balance sheet structure, which is quite reassuring.
A sharp downward currency adjustment would quickly result in a current account deficit and external trade improvement, like what happened in 2008.
Conditions are also likely to attract more foreign direct investment from stronger developed market corporates with high liquidity levels and a need for fresh growth alternatives for their shareholders.
The major investment theme leading emerging markets is reform, with short term current account pressures a welcome pretext to refocus government attention. The time has come for several countries to address competitiveness issues and the adequacy of GDP drivers.
This process will play out over the next two to five years. Some countries, such as Mexico, Malaysia and Poland, have already led the way, while those under more pressure, such as India and Indonesia, are following suit.
A fresh reform drive is needed to maintain the 4% average excess growth advantage over developed markets that emerging markets have consistently enjoyed since 2004.
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