Fireside Friday with… Kepler Cheuvreux’s Shiva Subramaniam

Head of credit emerging markets at Kepler Cheuvreux, Shiva Subramaniam, speaks to The TRADE about the attractiveness of emerging markets globally for traders, as well as a look at the lasting impact of geopolitical events on trading strategies.

Are global macro events making emerging markets more appealing to institutional investors? 

Despite the ups and downs in the global economy, emerging markets debt has been performing quite well this year. Positive returns have been seen across all segments of this asset class, even with some turbulence in US Treasury yields. But the most interesting part – local debt in these emerging markets has been shining particularly bright. The reason being that the central banks of these emerging economies have been on their toes, quickly responding to inflationary risks. They took action early on, initiating a remarkable series of rate hikes in 2021 that continued until early 2023. This swift action helped them witness falling core inflation over the last five months, giving them a head start in managing this economic challenge compared to the developed world.

This proactive approach allowed them to enjoy the benefits of falling core inflation much sooner than the developed world did.  During the second quarter, we saw some volatility in US Treasury yields, and the yield curve inversion deepened, causing some ripples in the market. However, in sovereign and corporate credit, the impact of higher Treasury yields was balanced out by credit spread compression. Meanwhile, emerging markets local debt continued to outperform core fixed income markets, mainly driven by yields. And interestingly, emerging markets currencies remained relatively stable against the US dollar.

Overall, the combination of positive returns in emerging markets debt, the responsiveness of their central banks, and the relative stability of their currencies has made these markets more appealing to institutional investors. As we move forward, it’ll be interesting to see how these dynamics continue to play out in the ever-changing global financial landscape.

What is the lasting impact of Russia-Ukraine on trading strategies in FX and emerging markets?

Economic models indicate that this turmoil is leading to reduced GDP growth and increased inflation in Central Europe, Middle East, and Africa region and that the war’s future is fraught with uncertainty and unexpected developments may amplify geopolitical risks and worsen its economic consequences. Russia has now become the most sanctioned country in the world and EM has lost one of the key volume contributors of FX, rates and equity markets, indices and ETF’s. Prices for foreign-traded Russian equity, bonds, NDF’s and OFZ’s have marked down to near-zero value and international funds have recognised the lack of investability of the Russian markets, leading to its exclusion from indices.

The fall in Russia’s FX reserves adds to the possibility of capital controls and this cannot be ruled out for markets. Middle Eastern oil exporters, Latin American countries such as Chile and Peru (major industrial metal exporters), and Argentina and Brazil (large agriculture product exporters), saw positive effects and benefitted from higher oil prices. The sovereign and Quasi bonds of these region saw spread compression while Asian countries like India and China did handle the situation by trading oil in local currency and at capped prices. 

Which emerging jurisdictions are traders aiming to move into?

There is a noticeable interest amongst institutional investors in EM Investment grade bonds that offer a minimum of five percent coupon and a long tenor of 10 plus years, especially in the Gulf Cooperation Council and Asia region.  The idea here is to cover the leverage cost and wait for the capital gains when US recission story intensifies in the last quarter of this year. India’s high-yield bonds are attracting attention, especially those in the commodity and ESG space, while some investors are divesting from China’s property-related bonds. Latin American markets are also catching the interest of investors. However, current spread levels for external debt are quite tight. Investment-grade spreads are trading near multi-decade lows, and BB (rating) spreads are considered to be at fair value. Although high yield and distressed debt may appear to be priced attractively, they may be more vulnerable to a potential global growth slowdown. 

Given the market conditions, investors are adjusting their strategies. Overweight positions are being seen in the BB sector, while caution is exercised regarding lower credit sectors for both sovereigns and corporates. Sovereign spread duration is underweight due to tight spreads in A and BBB credits, while US Treasury duration is favoured. When it comes to corporate credit, shorter duration instruments are preferred, as they offer opportunities for capitalising on pull-to-par, amortising features, or call options. These bonds are considered less exposed to global macroeconomic risks, making them attractive as idiosyncratic investments. Within industries, utilities and pipelines are preferred due to their transparent, long-dated cash flow streams.

What does this year have in store for global investors? 

Looking ahead to the second half of 2023, investors anticipate challenges, with consensus estimates projecting negative growth in the United States, continued stagnation in Europe, and a deceleration in China. The combination of declining growth and tightening monetary conditions in the United States and Europe leaves little room for errors from bottom-up sovereign events or global macroeconomic shocks. As a result, a conservative approach is being taken in terms of overall risk, with many investors opting for a highly liquid position avoiding markets like frontier Africa and CIS. This approach allows them to be ready to seize emerging market opportunities that may materialise at more attractive valuations in the future.