Boston - As the world continues to grapple with the health and economic implications of the COVID-19 pandemic, we believe the emerging-markets (EM) debt sector has reached a key milestone: While many factors remain difficult to quantify, we have potentially passed the point of "peak uncertainty" that jolted global markets in the first quarter. We believe a potentially bullish picture is taking shape for the future of EM debt.
From a macro perspective, the sell-off depressed the prices of EM bonds and currencies relative to the US dollar. The hit was greater for EM assets than for developed markets (DM), and they remain at lower levels. (EM assets did begin to rebound in April, however.) Moreover, the ultralow policy rates set by DM central banks have increased the yield advantage of EM debt.
The COVID-19 episode was something of a "coming of age" for a sector that routinely has experienced crashes and panics. For one, market access remains intact for investment-grade and higher-quality EM issuers. We have also seen EM central banks lower rates as stimulus - unremarkable for DM policy, but traditionally EM countries in trouble have been forced to raise rates to defend their currencies.
Most importantly, EM investors are not treating the sector monolithically. Across EM countries, we are seeing investors differentiate based not just on their oil dependence, but on varied policy responses to the virus and the potential impacts on health care systems, social dynamics, economies and finances. To the extent the market recognizes and rewards countries based on such fundamentals, it is bullish for the sector.
In this environment, fundamental global research capabilities will be especially important to gauge how well EM countries are managing the challenging health, social trends and policy factors. For example, we need to consider:
- How well the epidemic's curve is being controlled, the extent of the at-risk population and COVID-19 mortality rates.
- The strength of public support for mitigation efforts, and the time to effective treatments and vaccine.
- The ability of a significant part of the economy to work from home, and the degree to which such a shift is permanent and productivity-enhancing.
- The effectiveness of fiscal and monetary policies.
- How quickly external demand recovers for EM outputs, including factors like the price of oil and China's recovery.
Bottom line: A potentially bullish EM outlook is underpinned by deeply discounted prices and favorable value relative to DM assets. But the fundamental research capability required to identify potential winners and losers during this historic recovery has never been more crucial.