2024 Emerging Market Corporate Debt Outlook: Resilience in the Face of Global Risks

• While EM debt has long been characterized as a cyclical asset class given episodes of political, economic, and monetary risk, the growth of markets along with an accumulation of wealth and improvements in institutions, infrastructure, and industry have reduced this cyclicality over time.

• While investors must consider various risks heading into 2024 that must be managed within portfolios, we believe emerging market debt – particularly US dollar-denominated bonds issued by EM corporates – is well positioned to withstand those risks.

• The recent resilience of EM corporate bonds to geopolitical, macro, and policy risks underscores an often-overlooked investment reality for the past decade: that EM corporate bonds have consistently delivered stronger risk-adjusted returns than similarly rated developed market corporate bonds.

• As investors prepare for risks that might disproportionately affect portfolios concentrated in US or DM credit, we believe emerging market corporate bonds offer attractive value, lower realized volatility, and a direct response to challenges likely to roil financial markets in 2024.

• While EM debt has long been characterized as a cyclical asset class given episodes of political, economic, and monetary risk, the growth of markets along with an accumulation of wealth and improvements in institutions, infrastructure, and industry have reduced this cyclicality over time.

• While investors must consider various risks heading into 2024 that must be managed within portfolios, we believe emerging market debt – particularly US dollar-denominated bonds issued by EM corporates – is well positioned to withstand those risks.

• The recent resilience of EM corporate bonds to geopolitical, macro, and policy risks underscores an often-overlooked investment reality for the past decade: that EM corporate bonds have consistently delivered stronger risk-adjusted returns than similarly rated developed market corporate bonds.

• As investors prepare for risks that might disproportionately affect portfolios concentrated in US or DM credit, we believe emerging market corporate bonds offer attractive value, lower realized volatility, and a direct response to challenges likely to roil financial markets in 2024.

Emerging market debt has long been characterized as a cyclical asset class, given rolling episodes of political, economic, and monetary risk. While those risks still factor into the relative value of EM debt, the growth of markets over the past three decades, along with an accumulation of wealth and improvements in institutions, infrastructure, and industry, have reduced this cyclicality. 

That said, some areas of emerging market debt will likely see rising risks in 2024, which underscores the need for thoughtful analysis and prudent investment management. But we need only look back to recent history to maintain confidence in the asset class more broadly – not only in 2024 but over the long term, as a mature bond market with cyclicality that is now based more on ratings than simply on postal codes.

Geopolitical risks have not abated

Sadly, 2023 is ending with the formation of a new battlefield following the war between Israel and Hamas that erupted in early October. Despite the smaller size of the affected region, the market impact and potential for broader implications is similar to that of Russia and Ukraine. While Israel is a minor component of the global EM bond market – in contrast with the concentration of Russia and Ukraine in these indices at the outset of war in February 2022 (see chart) – the political and market ramifications of the conflict could be significant. 

Israel Is a Small Component of EM Bond Markets, But the War Could Have a Broader Impact

Index Exposure to Russia, Ukraine and Israel

Source: JP Morgan and PineBridge Investments as of 30 September 2023.

The potential humanitarian cost and the extent to which the conflict in Gaza will engulf other areas of the Middle East (or beyond) remain unknown. In 2022, once Russian sanctions were announced, asset prices marked down and ultimately removed from global bond indices risks, the potential escalation of fighting outside of Ukraine and the impact of the war on commodity prices weighed on broader market sentiment. Despite that uncertainty, contagion did not spill over into the global EM bond markets. In fact, outside of Europe – where underperformance was elevated due to the index write-downs of all Russian securities – US dollar-denominated EM bond markets performed in line with or, in the case of global EM corporates, better than US bond markets in 2022 (see chart).

Global EM Corporates Outperformed Developed Markets in 2022

2022 Total Returns and Excess Returns Over US Treasuries

Source: JP Morgan, Bloomberg and PineBridge Investments as of 30 September 2023.

2024 also features a busy election calendar, highlighted by general elections in India, Indonesia, Mexico, and South Africa as well as the US. 

Consequential Elections in 2024 Will Move Markets

Key EM Elections in 2024

Source: PineBridge Investments as of 18 October 2023.

For each election, shifts in polling and rhetoric across the political spectrum will cause markets to readjust expectations, pricing for potentially favorable or unfavorable outcomes. With more than 75 countries in the EM index universe, and many others off-benchmark, this political risk is part of the premium included in EM asset prices.

As emerging market countries have become more industrialized, accumulating wealth across an increasingly urban middle class, institutions have strengthened, reducing the tail risks that accompanied EM elections in the early days of the EM bond market. The expansion of the EM corporate bond market is also an important development, providing a broad set of bond issuers for which the underlying credit fundamentals are less sensitive to political risks. Nevertheless, a presumptively unfriendly election result can put as much or even greater selling pressure on corporate bonds than on sovereign bonds. 

For example, in June 2022, Gustavo Petro was elected to serve as Colombia’s first left-wing president, campaigning on a platform to address inequality in Colombia through a system of social programs funded, in part, by tax increases. Given the country’s already high account deficits, increases in social welfare spending and a potential restructuring of Colombia’s oil and gas industry were not well received by markets. Following Mr. Petro’s victory in the run-off election, spreads for Colombian corporate bonds – which had been trading in line with Colombia’s US dollar sovereign bonds – gapped out considerably, reflecting both sovereign concerns and worries that the Petro administration would be hostile to the oil and gas sector. As markets gained confidence that Colombia’s congress would constrain any legislation that might materially impair the private sector – particularly oil and gas – Colombian corporate spreads rallied through the sovereign.    

While each election is unique, this example helps illustrate two points: first, that many of the larger countries within EM today have strong government institutions that provide the checks and balances that have been a hallmark of stable Western governments; and second, that election risk might provide an opportunity to add corporate bond positions that have been mispriced by initial market reactions to political outcomes.

Colombia’s Presidential Elections Caused Wide Swings in Both Sovereign and Corporate Bonds

Colombia Sovereign and Corporate BBB/BB Spreads

Source: JP Morgan and PineBridge Investments as of 30 September 2023.

The US and China dominate the global economic outlook, but EM should be resilient

The outlook for 2024 is for below-potential global GDP growth, underpinned by the same concerns that worried investors for much of 2023: the potential for a US recession and for a structural slowing of China’s economy. While these risks may create periods of heightened volatility, we believe the fundamental economic outlook for much of EM will be resilient. 

Our view of the US economy includes four potential scenarios, ranging from the most severe stagflation to an extension of 2023, where strong labor markets and consumption support economic expansion despite Federal Reserve rate hikes. The more likely outcomes, in our view, are that US growth stabilizes below trend but above zero, or that the US posts negative growth and enters recession. While shifts in the probability of these scenarios will ultimately have an impact on monetary policy and, as such, create market volatility, we don’t see much risk of a US economic slowdown affecting expectations for stable EM growth in 2024. Among the economies most closely aligned with the US, in Mexico the potential drag of a US recession would be largely offset by the ongoing benefits of near-shoring on investment, manufacturing, and trade. Moving further south, an increase in trade across the Pacific has reduced Latin America’s dependence on the US. Globally, emerging markets have become far less dependent on exports to the US, so the risks of EM “catching cold from a US sneeze” are limited.

Moving east, China’s economic outlook will remain a consistent macroeconomic risk affecting financial markets in 2024. Expectations in early 2023 that a resurgence of China’s economy would boost global growth have failed to materialize, and China’s GDP is forecast to grow less than 5% in 2024. A measured use of monetary and fiscal policy will likely support economic stability, albeit at a lower rate of growth, creating a tight range for bull and bear forecasts – which is to say that even under more adverse conditions, China’s economy will expand and not serve as a catalyst of a material slowdown across EM. 

Key Exporters to the US and China: 2020-2022 Average

Source: Macrobond and PineBridge Investments as of 30 September 2023.

The likely resilience of EM to potential downturns in the world’s two largest economies is evident in broad expectations for EM growth, which the International Monetary Fund (IMF) forecasts at 4.0% for 2024, compared with just 1.4% for developed markets (DMs) – a growth differential of 2.6 percentage points (ppts), up from 1.5 ppts in 2022. Moreover, a significant number of EM countries have 2024 GDP growth forecasts exceeding those of the US and other core DMs (see table). Among countries with significant representation in US dollar EM bond indices, 17 are expected to deliver growth above the US and other DMs. Those countries represent over half the sovereign bond market and nearly two-thirds of the EM corporate debt market, but less than 2% of the US investment grade corporate bond market.

Growth Forecasts for Many EMs Exceed Those for the US and Other Developed Markets

Index MV & 2023 GDP Growth Forecasts (%)

Source: IMF, JP Morgan, Bloomberg and PineBridge Investments as of 18 October 2023.

Monetary policy uncertainty creates risks and volatility

Monetary policy, and specifically the coordinated raising of interest rates by global central banks, has been the primary risk to total returns across bond markets over the past two years.  With the federal funds rate a full 5 percentage points higher than it was less than two years ago as we enter 2024, two key questions are facing EM debt investors: How much longer will rate volatility persist, and what is the impact of higher rates on EM debt markets?

Since the Fed paused its rate hike cycle following the July 2023 increase, Treasury volatility has been elevated, as economic indicators and Fed-speak have alternated between bullish and bearish signals. That dynamic is likely to persist, given above-target inflation, a tight US labor market, and robust consumer spending. The war in Israel makes it unlikely that OPEC will accommodate the West with increased production, which would keep oil prices high and add to inflationary pressures. The Fed has maintained its optionality for both near-term rate increases and rate cuts in 2024. We expect that during the second half of 2024, the Fed’s focus will shift from fighting inflation to supporting a slowing economy, which would stabilize Treasury yields and support EM debt.

The impact of the Fed’s rate hikes on the US economy has been the subject of endless debate and remains a key macro concern heading into 2024. Historically, EM central banks have tended to follow the Fed in setting monetary policy during times of increasing global inflation. However, during this recent cycle, many central banks in regions that have historically had to be more active in fighting inflation moved more quickly to fight  inflationary pressures arising from post-Covid stimulus. In other regions where stimulus was smaller, the result was softer inflation and a more benign rate-hike cycle. So in aggregate, what we’ve seen are either central banks that acted sooner to curb inflation than the Fed and now have greater flexibility to deal with an economic slowdown, or those that have had to apply less financial tightening and, as such, created less risk that policy would hurt growth.

Central Bank Rate Shifts Have Varied Across Markets

Central Bank Policy Rates: Pre-Covid, Current Rate Hike Duration and Size

Source: PineBridge Investments as of 18 October 2023.

The impact of the Fed’s policy tightening not only influences the US economy, but also creates risks within the US dollar-denominated EM bond market. Issuers who borrowed prior to the start of the Fed’s rate-hike cycle will have the painful experience of refinancing in a materially higher-yield environment. Among sovereign issuers, most investment grade countries can issue in their local currency markets, an option that is particularly attractive in Asia and the Middle East, where policy rates in many countries are lower than in the US. Most below-investment-grade countries are not able to issue in their local currencies given the lack of a local investor base and an unwillingness among international investors to take on highly volatile foreign exchange risk, so those countries will have to refinance at considerably higher US dollar borrowing costs. 

This is less of a problem for US dollar EM corporate bonds, where more than three-fourths of the market comes from countries with active local markets, providing an alternative source of funding when US dollar borrowing costs become prohibitive. The ability of EM corporates to turn to local markets in tighter financial conditions adds an underpinning of supply-and-demand technical support, as net financing has been negative each of the past two years – meaning investors in the EM corporate bond market have received more cash than the new-issue market has printed.

EM Corporate Net Financing Has Been Negative

Source: JP Morgan and PineBridge Investments as of 3 October 2023.

The tightening of US monetary policy has also had a material impact on foreign exchange across the globe, as the US dollar has appreciated more than 10% since the start of 2022. Among sovereign issuers, while weaker currencies make for more competitive exports, they increase the cost of imports, constrain consumption, and inhibit foreign investment. There is a lower sensitivity to foreign exchange within the EM corporate bond market, however, as less than 15% of the market is vulnerable to currency vulnerability: 85% boasts either currency-matched revenues or FX hedges, issued from countries with pegged or managed currencies or from highly rated countries with current-account surpluses.

Most EM Corporate US Dollar Bonds Are Buffered From Currency Moves

EM Corporate USD Bonds by Currency Vulnerability

Source: JP Morgan and PineBridge Investments as of 19 September 2023.

Emerging market corporate bonds can weather challenges in 2024

Heading into 2024, investors must consider various uncertainties and risks that must be managed within portfolios. Yet in recent history, we see evidence that emerging market debt, particularly US dollar-denominated bonds issued by EM corporates, are well positioned to withstand those risks. The recent resilience of EM corporate bonds to political, economic, and monetary risks are the latest chapter in what has been an often-overlooked investment reality for the past decade: that EM corporate bonds have consistently delivered stronger risk-adjusted returns than similarly rated DM corporate bonds (see chart).

EM Corporate Risk-Adjusted Returns Look Attractive Versus DMs

Trailing 10 Year Annualized Returns and Volatility (USD)

Source: JP Morgan, Bloomberg and PineBridge Investments as of 30 September 2023.

As investors prepare for risks that might disproportionately impact portfolios concentrated in US or DM credit, we believe emerging market corporate bonds offer attractive value, lower realized volatility, and a direct response to the challenges likely to roil financial markets in 2024.