In Short: Trade shifts shouldn't diminish opportunity in EM bonds

02-13-2017

Given the new administration’s stance on America-first trade policies—and potential negative impacts to countries such as China and Mexico—heightened concern regarding emerging-market (EM) bonds isn’t surprising. But the reality is that performance of the asset class over the past few months has been solid. The reason why can be explained by examining the main drivers for EM economies.

First, strong U.S. economic growth almost always provides a global boost, especially to EM economies. The anticipated added stimulus in the U.S. from tax cuts, potential infrastructure spending and a more business-friendly regulatory environment can create a positive feedback loop for emerging markets. While not all EM countries and businesses will benefit, a number of areas could, including commodity-related economies that experience increased demand related to more U.S. infrastructure spending. In addition, countries such as Brazil and Argentina that historically have not had a high level of trade with the U.S. may benefit if they are able to forge new bilateral trade deals, gaining an edge over those affected by renegotiation of existing, complex deals.

Second, a shift in geopolitics will favor certain EM countries. Russia and Egypt are just two examples. It’s clear that the administration wants to improve relations with Russia, which would certainly welcome the economic boost it would receive as a result of closer ties. As a strong U.S. ally in the Middle East, Egypt is likely to see advantages. A changing dynamic, even with obvious challenges, creates opportunities to add value.

Overall, we expect EM bond performance to surprise to the upside, albeit with some volatility. The case for investing in the asset class—continued demand for yield, improving EM growth potential, the diversity of economic drivers and attractive valuations—remains strong. As we’ve always advocated, it’s unwise to paint all of EM with the same broad brush—and that certainly applies to EM fixed income, especially as the U.S. undergoes significant changes in its own trade and economic policies. It’s an environment where there are likely to be winners and losers among countries, companies and currencies, and where security selection will play an increasingly important role.