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EM debt rally cools in Q319

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      By Emerging Markets Debt TeamEaton Vance Management

      Boston - The broad 2019 emerging-markets (EM) debt rally cooled in the third quarter - local-currency EM debt lost a little ground, while external (dollar-denominated) debt managed to produce small gains (see chart below).

      Local-currency EM debt, as measured by the J.P. Morgan GBI-EM Global Diversified Index, fell by 0.79%, due to the strong U.S. dollar and negative sentiment around Argentina's election. Interest rates and carry contributed positively to the performance of the GBI-EM, but these factors were more than offset by declining foreign currency exchange (FX) rates versus the U.S. dollar.

      Sovereign credit, represented by the J.P. Morgan EMBI Global Diversified Index (EMBI), gained 1.51%. Both sovereign and credit spreads within the EMBI widened, and detracted from performance, but that was more than offset by the positive impact of falling U.S. Treasury yields.

      Corporate credit, represented by J.P. Morgan CEMBI Broad Diversified Index, gained 1.66%. The CEMBI was also hurt by sovereign spread widening, but the positive contributions of tightening corporate spreads and falling U.S. Treasury yields more than offset that.

      FX and wider sovereign spreads cool off EM debt rally.

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      Looking Ahead

      The interest-rate rally of 2019 continued in the third quarter, recording the best year-to-date performance by this risk factor in nearly a decade. This rally has left valuations for many countries looking rich, while risks to global growth have risen. However, some countries, particularly higher-yielding ones, continue to look cheap.

      FX performance was quite weak in the quarter, particularly for high-beta currencies, led by the Argentine peso. The risk factor will continue to be supported by dovish monetary policy, particularly from the U.S. Federal Reserve, while fundamentals in many countries are improving at the margin.

      For EM corporates, while the headlines were dominated by negative situations in Argentina and Asia high yield, we continue to see steady fundamental improvements elsewhere in the corporate sector, particularly Brazil, Ukraine, Russia and Turkey. The external environment should continue to be supportive, though commodity prices are a particular risk for EM corporates.

      Country-specific problems in Argentina and Lebanon drove aggregate sovereign spreads wider, but nearly half the countries in our universe saw spreads tighten moderately. Sovereign spreads continue to show significant differentiation among countries.

      Bottom line: While the 2019 rally has led to relatively less compelling valuations, we expect dovishness from the Fed and the European Central Bank (ECB), along with improving fundamentals, to support continued strong performance. However, risks to this outlook remain elevated, specifically around trade and geopolitical stability.

      Investing involves risk including the risk of loss. In emerging market countries, the risks may be more significant in regards to sensitivity to stock market volatility, adverse market, economic, political, regulatory, geopolitical and other conditions.