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Market View

Easier financial conditions have been almost always positive for emerging-market debt, especially when interest-rate differentials are growing larger between advanced and emerging markets.

In Brief

  • The share of credits with sub-3% yields now accounts for approximately 84% of the Bloomberg Barclays U.S. and global aggregate indexes.
  • We believe the search for yield will increase the demand for higher-yielding emerging-market (EM) credit and increase capital flows to EM countries which should facilitate their economic growth.
  • EM central banks don’t have to fret about potential negative impacts of their own rate cuts on their individual currencies since nearly all the EM countries are cutting, in our opinion.

 

With global central banks moving in near-total synchrony to lower key interest rates, and the share of credits with sub-3% yields now accounting for approximately 84% of the Bloomberg Barclays U.S. and global aggregate Indexes, we expect an increase in demand for higher-yielding emerging-market (EM) bonds.

“Emerging markets offer the potential for attractive incremental yield opportunities for investors willing to take on more credit risk,” according to John Morton, Portfolio Manager, Emerging Markets Debt. “And easier financial conditions have been almost always positive for emerging-market debt, especially when interest-rate differentials are growing larger between advanced and emerging markets,” he continued.

Under such conditions, “global capital flows into emerging markets which, in turn, typically facilitates  higher growth for EMs,” he said.   

Morton believes the U.S. Federal Reserve Bank’s (Fed) easing trend “will give an additional degree of freedom to EM central banks to reduce their rates without concerns for their currencies.”

Lord Abbett’s foreign exchange specialist, Leah Traub, agrees.  On July 18, 2019, the central banks of Indonesia, South Korea, and South Africa all cut their interest rates by 25 basis points at their meetings – joining those EMs that had already lowered rates in 2019: Chile, India, Malaysia, Russia, Turkey, and the Philippines.  “Emerging markets don’t have to fret about potential negative impacts on their exchange rates since everyone else is cutting,” Traub said.

“We believe that expectations of a Fed rate cut at their meeting on July 31, emboldened EM central banks to also cut rates in order to support their relatively weak economic growth and low inflation,” she said.

 

Chart 1.  The Share of Low-Yielding Credits in Global Portfolios Has Increased
Share of credit in benchmark aggregate bond indexes yielding less than 3%, as of April 30, 2019

Source: Barclays Research. US Agg = Bloomberg Barclays U.S. Aggregate Index.  Global Agg=Bloomberg Barclays Global Aggregate Index. For illustrative purposes only and does not represent any specific portfolio managed by Lord Abbett or any particular investment. Past performance is not a reliable indicator or guarantee of future results.

 

In addition to increased global liquidity, other sources of support for emerging market investment opportunities include more stable commodity prices.  As an indicator of improving conditions in EM markets, currencies of countries with current account deficits (Turkey, South Africa, and Mexico), those with strong ties to the U.S.-China trade supply chain (China, South Korea, Chile), and those of commodity exporters (Russia and Colombia) have all seen positive movement  since May 2019.

Looking into the second half of 2019, developments in the U.S.-China trade talks will be closely watched for their potential economic impact on the U.S.-China trade supply chain.

Summing Up
The gap in yields between EMs and developed markets is likely to attract investors to EM credit opportunities, especially those investors willing to take on more credit risk. We anticipate these fresh capital inflows may support EM economies at a time when some are experiencing weak economic growth and low inflation. This higher growth differential relative to advanced markets will also facilitate flows into the emerging world. At the same time, EM central banks have been emboldened to lower interest rates by the easing trend apparent in the advanced countries. Among the events that will impact EMs over the remainder of 2019 are the U.S.-China trade talks, which we will watch closely for their potential impact on the U.S.-China supply chain.  

 

Glossary of Terms

One basis point is equivalent to 0.01% (1/100th of a percent) or 0.0001 in decimal form.

A current account deficit is a measurement of a country's trade where the value of the goods and services it imports exceeds the value of the products it exports.

The Bloomberg Barclays U.S. Aggregate Bond Index represents securities that are SEC-registered, taxable, and dollar denominated. The index covers the U.S. investment grade fixed rate bond market, with index components for government and corporate securities, mortgage pass-through securities, and asset-backed securities. Total return comprises price appreciation/depreciation and income as a percentage of the original investment.

The Bloomberg Barclays Global Aggregate Bond Index is a broad-based measure of the global investment-grade, fixed-income markets. The three major components of this index are the U.S. Aggregate, the Pan-European Aggregate, and the Asian-Pacific Aggregate indexes. The index also includes euro dollar and euro/yen corporate bonds, Canadian government securities, and U.S. dollar investment-grade 144A securities.

Indexes are unmanaged, do not reflect the deduction of fees or expenses, and are not available for direct investment.

Statements concerning financial market trends are based on current market conditions, which will fluctuate.

This article is being provided for informational purposes only and is intended to illustrate certain information analyzed during the research process. It does not constitute a recommendation nor investment advice, and should not be used as the basis for any investment decision. This is not a representation of any securities Lord Abbett purchased or would have purchased or that an investment in any securities of such issuers would be profitable.

A Note about Risk: The value of investments in fixed-income securities will change as interest rates fluctuate and in response to market movements. Generally, when interest rates rise, the prices of debt securities fall, and when interest rates fall, prices generally rise. Bonds may also be subject to other types of risk, such as call, credit, liquidity, interest-rate, and general market risks. High-yield securities, sometimes called junk bonds, carry increased risks of price volatility, illiquidity, and the possibility of default in the timely payment of interest and principal. Moreover, the specific collateral used to secure a loan may decline in value or become illiquid, which would adversely affect the loan’s value. Longer-term debt securities are usually more sensitive to interest-rate changes; the longer the maturity of a security, the greater the effect a change in interest rates is likely to have on its price. Lower-rated bonds may be subject to greater risk than higher-rated bonds. Investing in international denominated and/or domiciled securities may involve heightened risk due to currency fluctuations, and economic and political risks, which may be enhanced in emerging markets. The securities markets of emerging countries tend to be less liquid, especially subject to greater price volatility, have a smaller market capitalization, have less government regulation and may not be subject to as extensive and frequent accounting, financial and other reporting requirements as securities issued in more developed countries.

No investing strategy can overcome all market volatility or guarantee future results. Statements concerning financial market trends are based on current market conditions, which will fluctuate.

Forecasts and projections are based on current market conditions and are subject to change without notice. Projections should not be considered a guarantee.

There is no guarantee that markets will perform in a similar manner under similar conditions in the future. International investing involves risks, including risks related to foreign currency, limited liquidity, less government regulation and the possibility of substantial volatility due to adverse political, economic or other developments. These risks are often heightened for investments in emerging/developing markets or smaller capital markets.

This article may contain assumptions that are “forward-looking statements,” which are based on certain assumptions of future events. Actual events are difficult to predict and may differ from those assumed. There can be no assurance that forward-looking statements will materialize or that actual returns or results will not be materially different from those described here.

The information provided herein is not directed at any investor or category of investors and is provided solely as general information about our products and services and to otherwise provide general investment education. No information contained herein should be regarded as a suggestion to engage in or refrain from any investment-related course of action as Lord, Abbett & Co LLC (and its affiliates, “Lord Abbett”) is not undertaking to provide impartial investment advice, act as an impartial adviser, or give advice in a fiduciary capacity with respect to the materials presented herein.  If you are an individual retirement investor, contact your financial advisor or other non-Lord Abbett fiduciary about whether any given investment idea, strategy, product, or service described herein may be appropriate for your circumstances.

The opinions in Market View are as of the date of publication and are subject to change. Additionally, the opinions may not represent the opinions of the firm as a whole. The document is not intended for use as forecast, research or investment advice concerning any particular investment or the markets in general, and it is not intended to be legal advice or tax advice. This document is prepared based on information Lord Abbett deems reliable; however, Lord Abbett does not warrant the accuracy and completeness of the information.

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