Emerging Market Local-Currency Debt Faces Challenges Amid Ongoing Conflict

Local-currency debt in emerging markets is experiencing significant losses, particularly since the onset of the Iran war, which has led to a decline of over 4.5%. This downturn is exacerbated by rising oil and gas prices, which have heightened inflation expectations and increased market volatility. Thierry Larose, a portfolio manager at Vontobel Asset Management, noted that local-currency bonds have become a primary casualty of the current risk-off environment.

Bloomberg

The conflict has prompted policymakers across various regions, including Eastern Europe and Latin America, to reconsider their monetary policies. Many are signaling the need to maintain elevated interest rates or even tighten them further to combat inflation driven by higher energy costs. The Federal Reserve has also expressed concerns that inflation risks could impede planned rate cuts, while a European Central Bank official suggested that rate hikes may be necessary soon.

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The performance of emerging market currencies has varied significantly. Only six out of 22 major emerging market currencies have appreciated against the dollar this year, a stark contrast to 17 currencies that were gaining prior to the conflict. South African and Hungarian bonds have reported losses of around 10% this month, leading to a reevaluation of investment strategies. In contrast, Colombia's local bonds have performed better, gaining 3.6% as traders had already anticipated interest rate hikes.

Bloomberg

Investment strategies are shifting as market participants reassess their positions. Larose is reducing exposure to high-beta currencies in Latin America and Eastern Europe, favoring more stable currencies like the South Korean won and Taiwanese dollar. Meanwhile, Yacov Arnopolin, a senior portfolio manager at Pimco, indicated that the current market conditions may lead to an overestimation of necessary interest rate hikes in emerging markets.

Bloomberg

Despite some positive outlooks, there are concerns regarding the volatility in emerging markets. Sergey Dergachev, head of EM corporate debt at Union Investment Privatfonds GmbH, highlighted the difficulties in hedging risks amid uncertainty, particularly in the Middle East and North Africa. Lupin Rahman, a former EM portfolio manager at Pimco, advised investors to manage short-term volatility while not abandoning medium-term opportunities in local markets.

Bloomberg

Investment firms are advising caution while navigating the current landscape. Wim Vandenhoeck, co-head of emerging markets debt at Invesco, noted that if markets stabilize, central banks in Brazil and Mexico may still pursue easing monetary policies. He emphasized the potential for relative-value trade opportunities in Latin America, suggesting that this region could yield more winners than Asia in a global growth-shock scenario.

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“EM local-currency bonds have, unsurprisingly, become the primary casualty of the current risk-off environment,” — Thierry Larose, Portfolio Manager, Vontobel Asset Management

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“Volatility is likely to persist in the near term as the asset class sees outflows of tourist money,” — Unnamed Analyst

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“We’re just starting to see value in the long-end of curves in Brazil, South Africa and the Czech Republic,” — Yacov Arnopolin, Senior Portfolio Manager, Pimco

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As the situation evolves, investors are urged to remain vigilant and adaptable to the changing dynamics of the emerging markets landscape.

Bloomberg