October Emerging Markets Update

Monthly Commentary

November 25, 2019

We remain cautiously optimistic about the outlook for Emerging Markets (EM) debt through year-end and beyond. From a technical perspective, seasonality in the final months of the year tends to be positive for risk asset returns and with an EMBI spread of 328 basis points (bps) (354 bps on a like-for-like basis relative to index composition at the beginning of the year), USD-denominated EM sovereign debt is one of the only fixed income asset classes trading near to its historical average.

10 Year Spread Range

Source: JP Morgan; Data as of October 31, 2019

Looking forward, even as the growth outlook remains uncertain, the global backdrop for 2020 should be moderately supportive of Emerging Market debt assets. We believe global growth will improve slightly year-over-year in 2020 and is more likely to overshoot than undershoot, as indicated by the green shoots already appearing in the European Union (EU) and Japan, and economic indicators starting to surprise on the upside in a number of EM economies, especially in Latin America.

Still, we believe the major Central Banks will remain cautious and biased toward easing. This more accommodative policy stance could extend the current low rate environment into the medium term, which we believe will continue to drive inflows into higher-yielding asset classes, like Emerging Markets Debt. This environment should also provide EM central banks the policy space to enact pro-growth measures as needed, especially as inflation remains relatively benign.

Geopolitical risks will likely remain elevated and complicate the outlook for 2020, but we could see improvements in one or more of the more important geopolitical issues, such as Brexit and/or the U.S./China trade war. While we are not convinced we will see a meaningful trade deal or major concessions from either side, we believe some freeze in the conflict is progressively likely. Recent headlines suggest that the U.S. and China are progressing to some form of a trade deal.

Our base case is for a modest “Phase 1” U.S.-China trade deal involving no further escalation, and possibly, a slight roll back of tariffs. Imposition of the December 15 tariffs is likely to be delayed if there is no agreement by then. At the same time, there is a non-negligible risk of further escalation given reluctance from China to commit to large scale agricultural purchases and the U.S. to roll back tariffs significantly. In addition, Congressional passage of the Hong Kong legislation, while unlikely to derail a deal, highlights the non-trade issues that could complicate consummating and maintaining one.

Should we see signs of a broader turnaround in global growth—notably in China and the EU—and/or a de-escalation in the larger geopolitical risks, EM local currency debt could present an interesting opportunity in 2020, especially as EMFX currently trades near historic lows relative to the dollar. In the interim, we believe Emerging Markets debt returns will be largely driven by carry.

 

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This material is for general information purposes only and does not constitute an offer to sell, or a solicitation of an offer to buy, any security. TCW, its officers, directors, employees or clients may have positions in securities or investments mentioned in this publication, which positions may change at any time, without notice. While the information and statistical data contained herein are based on sources believed to be reliable, we do not represent that it is accurate and should not be relied on as such or be the basis for an investment decision. The information contained herein may include preliminary information and/or "forward-looking statements." Due to numerous factors, actual events may differ substantially from those presented. TCW assumes no duty to update any forward-looking statements or opinions in this document. Any opinions expressed herein are current only as of the time made and are subject to change without notice. Past performance is no guarantee of future results. © 2019 TCW