Market, Opinion, Fixed, Income, EM The Best Bet

Fixed Income EM The Best Bet

Readers will know that we have been bullish the emerging markets (EM) debt asset class for a long time, constantly promoting the improving fundamentals. Two weeks ago, in EM Debt Still Looking Good, we suggested that the volume of inflows into this market would help take it higher. This is looking more and more likely.

Aside from our favourite instrument, the Russian US$ Global 30 bond, we said you may want to take a look at the long end in Mexico, Colombia, Peru and Venezuela. All have hit new highs and still look good, with the spread on the EMBI+ at its narrowest point since 1997.

The improvement in fundamentals, due to sound monetary, exchange rate and fiscal policy decisions has allowed the asset class as a whole to move up the credit curve, as ability to pay becomes far less of a concern. As a result, more than 40% of the EMBI+ is now rated as investment grade, as opposed to roughly 10% in 1997.

Against this backdrop, the attraction of a fiscally improved asset paying a higher yield than your average G7 instrument is all too appealing. Furthermore, the external environment is helping EM debt. Although we correctly assumed last week that the US bond market had overreacted to the economic impact of Hurricane Katrina – with the 10-year yield rising over 12bps at one stage – we still think that US yields will stay low on an historical basis. In fact, as we have long argued, the more the Fed ups rates to contain inflationary pressures, the more attractive US long bonds become, and in turn, EM debt.

The investment cocktail of robust global economic growth, high commodity prices, benign long-term inflation, low yields on major bonds and solid domestic fundamentals is still rather explosive, and could well see the spread on the EMBI+ halve over the coming years.

Indeed, this search for sensible levels of yield is a growing concern for an ageing G7 population. With this in mind, the increasing amount of pension and general fund-related money, as well as foreign central bank money, pouring into global bond markets, both G7 and EM alike, will provide an ever strengthening support base. Against this backdrop, any shock induced or short-term inflation fuelled correction is likely to be met with a wave of fresh buying.

Visit Market Opinion [+]