2021 Outlook: Three Questions for the Emerging Markets Debt Sector Team
- Emerging markets (EM) corporate spreads have almost recovered to year-end 2019 levels, as strong issuance was met with even stronger investor demand. Do you see this trend continuing into 2021?
- What is your outlook for emerging market foreign exchange (EMFX)? Is now the time to get into EMFX?
Yes, we see several factors that could drive EM corporate spreads tighter from here. The global economic recovery is the most important factor in our view. We believe widespread fiscal and monetary support and vaccination campaigns around the world could support a strong recovery. Additionally, spread levels have remained wide to historical ranges. EM high yield and investment grade both currently offer yield premiums versus their counterparts in developed markets; we believe this will attract yield-hungry investors to the asset class. Surprise upward growth revisions in Q4 2020 would also tend to support spread tightening.
We acknowledge that valuations are more challenged. Absolute yields have fallen, but considering the case for recovery, EM spreads likely have room to tighten toward their historical average range.
After a volatile year, we have an optimistic view of EM currencies for 2021. Risk sentiment has remained strong, and we currently consider many currencies undervalued. We believe the US dollar will continue to weaken in 2021 as the economic recovery gains momentum. This macro backdrop combined with higher prices for metal and food commodities could provide a nice tailwind for many currencies, such as the Brazilian real and the South African rand. Terms of trade1 have already improved significantly in these countries, as shown in the charts below. This should encourage economic growth, helping to support stronger currencies. The Turkish lira’s volatility made headlines during the last quarter of 2020, but a recent shift toward more orthodox economic policies from Turkey’s central bank could lead the lira to a better path in 2021.