2024 Midyear Emerging Market Debt Outlook: EM Economies Flip the Script

• We expect continued support for EM debt in the second half of 2024, with a favorable economic outlook for EM relative to developed markets and normalization of rates in the US and Europe boosting the flow of capital to higher-yielding international assets.

• These factors support an ongoing secular shift in perceptions of the asset class, with more investors now taking a longer-term strategic view of the asset class as a core fixed income allocation, rather than simply a tactical play.

• Valuations across fixed income markets are tight, with prices discounting potential risk outcomes as carry trades look increasingly crowded. We think a reassessment of EM risk premia is in order given the segment’s faster growth, declining inflation, and more stable governmental institutions and political processes.

We see continued support for emerging market debt in the second half of 2024, with a favorable economic outlook for EM relative to developed markets. Looking ahead, the normalization of rates in the US and Europe is likely to spur an increased flow of capital to higher-yielding international assets. These factors lend support to an ongoing secular shift in the traditional view of emerging market fixed income: More investors are now taking a longer-term strategic view of the asset class as a core fixed income allocation, rather than simply a tactical play.

The old EM inflation story no longer holds

High inflation has historically contributed to higher emerging market risk premia and cautious sentiment, as it presented cyclical challenges to local currencies, fiscal balances, monetary policy, and domestic consumption. Yet the picture today is much different. Looking back over the past three years, Covid-related monetary and fiscal stimulus sparked a surge of inflation globally. However, the stimulus across emerging markets was more measured than in the US and Europe, and EM central banks were faster to control inflation with tighter monetary policy than their major central bank counterparts. The result was less-severe inflation across most emerging market economies compared with their developed market counterparts (see chart).

Emerging Market Inflation Reverses the Old EM/DM Dynamic

EMs saw a much milder post-Covid inflation bump than developed markets, reversing the historical pattern

Source: IMF and PineBridge Investments as of 31 May 2024. For illustrative purposes only. Core EM inflation excludes Argentina, Turkey, Russia, Ukraine, Lebanon and Sri Lanka.

Free of substantially above-trend inflation, emerging market economies have been less affected by high policy rates, and EM consumers have seen less of an impact on their purchasing power. Lower inflation and a more benign monetary policy response continue to benefit emerging market economies, which have higher growth outlooks than in the US and Europe.

Global EM Growth Forecasts Are Outpacing Developed Markets

2024 & 2025 GDP Growth forecasts (%)

Source: IMF and PineBridge Investment as of 31 May 2024. For illustrative purposes only. Any opinions, projections, forecasts, and forward-looking statements presented are valid only as of the date indicated, are speculative in nature, and are subject to change.

While markets grapple with whether central bankers in the US and Europe can navigate a soft landing for inflation, outlooks across emerging markets are considering more benign scenarios for investors. In Asia, concerns regarding China’s growth outlook – with a forecast range of 4%-5% – should be offset by robust growth in India, Indonesia, the Philippines, and Malaysia (see our 2024 Midyear Asia Fixed Income Outlook for more). The global oil market is expected to remain in a deficit, with demand outstripping supply for the remainder of 2024, providing a boost to oil producers across emerging markets. The outlook for other commodities is also favorable, as producers across emerging markets benefit from increased structural demand for raw materials associated with energy transition and advanced technology, while precious metals prices remain elevated in the midst of global uncertainty.

While idiosyncratic risks will always exist in such a diverse group of countries, structural changes across global value chains and within domestic economies are likely to boost overall emerging market growth in 2025.

Markets take EM election results in stride, but November looms large

2024 is a monumental year for geopolitics, with a record number of voters participating in elections across the globe. While the US election still looms in November, most of the major elections across emerging markets have already concluded. While no single takeaway can be drawn from emerging market election results in 2024 – consolidation of governing authority in Mexico and Indonesia stands in contrast to losses of ruling majorities in India and South Africa – the market reaction has been relatively subdued, even when the results were not “market friendly.” And while there have been instances when expectations were upended, election results across Europe have been similarly unpredictable, with political polarization seemingly the only outcome markets can count on.

The US election remains a potential risk event that is already creating unpredictability that will likely persist through November. The trade position of the next US administration is most relevant to emerging markets, and while campaign rhetoric may sound a hawkish tone, inflation concerns and legislative barriers to sweeping restrictions should inform expectations on trade policy. Furthermore, global supply chains have proven resilient to US trade protection over the past eight years, with an increase in intra-EM trade and greater trade regionalization, such that we would not expect a massive decline of EM exports in the face of increased US trade protection.

EM corporate issuers compare favorably with DM peers

Many investors view emerging market fixed income as a predominantly sovereign asset class, but the reality is that dollar-denominated emerging market corporate bonds – with a market capitalization of $2.5 trillion – constitute a substantially larger market than hard currency sovereigns.

The positive sovereign outlook lends support to emerging market corporate issuers, as sovereign ratings have a direct impact on corporate credit ratings. While the global economic outlook is less certain, the acceleration of emerging market growth is driven in large part by strength in domestic economies, which benefits many sectors of the corporate bond market – consumer, financial, and utilities, for example.

Macroeconomic risks shine a light on underlying credit fundamentals, and here we find another supportive pillar for our largely positive emerging market outlook: EM corporate issuers tend to have greater financial flexibility than developed market corporates as a whole, with leverage ratios substantially lower than those of similarly rated DM peers (see chart). That said, while credit fundamentals are strong across EM corporates, careful issuer selection takes on even greater importance in an environment of tight financial conditions and macroeconomic uncertainty.

The shift from a tactical to core allocation continues

Valuations across fixed income markets are tight, with prices discounting potential risk outcomes as carry trades look increasingly crowded. As an active manager of emerging market bond portfolios for three decades, we believe the current outlook supports a broader shift in market sentiment from viewing EM debt as a cyclical, carry-driven asset class to a meaningful segment of global bond markets. Moreover, we think a reassessment of emerging market risk premia is in order given the segment’s faster growth, which is becoming more decoupled from macroeconomic cycles and global capital flows, along with declining inflation and more stable governmental institutions and political processes. Such a shift in view should lead to an increase in EM debt allocations as investors take advantage of high all-in yield levels.

Indeed, much has changed since the first EM “Brady bonds” were issued in the late 1980s, with emerging markets’ share of world GDP rising from just 20% in 1987 to 46% in 2023. Economic growth has been both supportive of and driven by an increase in population (from 3.8 billion in 1987 to 6.8 billion in 2024), a growing urban middle class, an expanding industrial base, and strengthening institutions. This evolution of demographic and structural factors supports our constructive view of the asset class.

Looking ahead, the EM economic outlook is favorable relative to developed markets, and normalization of rates in the US and Europe should increase the flow of capital to higher-yielding international assets. We believe investors will continue to reconsider traditional views of emerging market fixed income as a tactical allocation in favor of a longer-term strategic view of the asset class as a component of core fixed income allocations. With our long history in EM debt investing and deep understanding of the asset class, we can help investors navigate this shift.