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Fixed income

Key Takeaways from the IMF and World Bank Meetings in Washington D.C.

Building with lights

Bottom Line Up Front: We remain comfortable exhibiting a modest risk posture in the six/seven out of ten range. We still favor emerging market (EM) corporates given their diversity and attractive shorter-duration, higher-yielding profile with some optimism tempered as high-quality spreads are tight compared to U.S. and developed market (DM) corporates. Our comfort with EM high yield hard currency sovereigns and select idiosyncratic opportunities remains intact. We have added to local currency given attractive rates and a neutral to positive view on foreign exchange markets (FX) with room to add if a broader selloff materializes.

Renfrew’s Report

The same, but different: This year’s IMF and World Bank meetings retained many of the same themes as last year’s meetings. However, the degree of potential shocks seem to largely be a function of higher rates, without as much fear of a hard U.S. landing (as misguided as that view may be). Below are four key themes:

  1. U.S. inflationary pressure: This theme remains firmly intact as U.S. job growth remains impressive, growth is robust, and inflation is stickier than expected - so higher-for-longer rates continue to prevail.
  2. Israel/Mideast back in the spotlight: Rising geopolitical tensions along with the hotspot adding in Iran/Iraq to the broader conflict - but importantly the latest attack by Iran and response by Israel seem to be minor, helping avoid escalation and highlighting a coordination among the Israeli/US/Gulf alliance that was noteworthy.;
  3. Continued China malaise: the poor sentiment driven by President Xi’s political dominance hasn't let up.
  4. U.S. elections: perhaps a greater risk for markets than the heavy EM election cycle. A Trump 2.0 playbook with high tariffs against China and lack of support for Ukraine puts European policymakers in a very uncomfortable position.

Sanctions in the spotlight: As sanctions are increasingly being used as a means of weaponry between the West and its adversaries, their implications are becoming increasingly complex and pronounced. During the meetings, the U.S. State Department's Director of Sanctions Policy highlighted that one of the first sanctions program leveled at Zimbabwe was recently wound down as the current efforts were no longer effective or meaningful in changing behavior. While last year sanctions on Venezuela were relaxed, President Biden has had to go back to imposing sanctions again (though exceptions may continue for Chevron and other oil producers). The relevance of Venezuela’s migration story is described as having had both an impact on U.S. growth and containing wage pressures, despite the political backlash from border security concerns.

Country-level progress since Marrakech: The landscape has changed significantly since October’s IMF meetings in Morrocco. Argentina’s government is firmly in place and hasn't been crippled by tough reforms (yet). Turkey has maintained its orthodoxy even after losing municipal elections in March. Brazil's landmark Value Added Tax reform and monetary policies (they won Central Bank of the year award) has led to boosts in IMF's projected growth rates. Nigeria's Dangote new refinery is at 50% capacity and the deep-water port will provide that project with a lot of flexibility that will ultimately benefit the country's balance of payments. Serbia has built up ample fiscal buffers and remains on a path to investment grade despite some large-scale spending projects that is likely to lead to higher fiscal spending in next 3 years; South Africa is finally seeing better electricity production and load shedding has not been an issue this year (however, water issues have popped up as a recent challenge at the municipal level). Peru’s president and congress have a stability pact through 2026 which might allow for revisions to the fiscal rule to modernize it for the post pandemic environment.

Lean into market complacency: While the outlook for EMD appears quite positive overall, unexpected risks may warrant some caution. In our view, there are a few unpriced risks that bare attention as their implications are monumental to our investment universe and broader market sentiment. These risks include the potential for an oil shock resulting in prices over $100/barrel; a China growth meltdown; a hot conflict between the U.S. and China and/or Russia/NATO; a Trump win in the November U.S. presidential elections; and/or another global pandemic.

Espinosa’s Evaluation

Macro background provides EMD solid footing: I came away from Washington DC with a sense that the overall risk tone from the IMF meetings was balanced, based on the anchor of broadly solid economic growth momentum in the U.S. and EM. This background helped solidify our preference for EM high yield sovereigns and select idiosyncratic macro-opportunities.

Capital markets and IMF/World Bank financial support reduce external financing risks: Compared to recent IMF meetings where top-down macro themes dominated, investors were perhaps more focused on the track record of IMF programs and macro stabilization and reform programs.

  • El Salvador: El Salvador’s IMF meeting was one of the most well-attended and the general takeaway was that the likelihood of a short-term IMF deal is very low. President Bukele’s prioritization of bitcoin serves as a major issue and hurdle for the IMF. Despite the lack of an imminent IMF program, El Salvador does have sufficient external funding to muddle through for the next few years.

The trajectories for rates and inflation across many countries appear achievable There was extensive debate and concern over when, or if, the Fed will cut rates and how the rest of the world will react. We do not anticipate a straight line and expect bumps along the way. That said, across most of EM central bank meetings I attended, the tone leaned more hawkish and for those on a current easing path, there was a sense of acting more measured with an openness to data dependency either from the local economy or externally (i.e. the Fed and other major DM central banks).

Is consensus too pessimistic on the EM foreign exchange market (FX)? The consensus thinking leaned toward a continuation of USD strength – this presents a potential opportunity to choose the appropriate spots in local markets to drive relative performance from a somewhat contrarian positioning with a focus on economies where inflation remains well anchored, and risk-adjusted real yields remain attractive.

  • South Africa: The expected delay on Fed cuts has forced several central banks to lean more hawkish and South Africa is one of those examples. In addition to the Fed, upcoming elections and sticky core inflation have kept South African Reserve Bank (SARB) on hold. The SARB is expecting to decrease its inflation target (from 4.5% to 3%) by end of next year. This, in our view, adds an extra layer of hawkishness to their recent decision-making. Markets have since priced out all cuts, and are even pricing the potential for small hikes post the IMF meetings.

Ascending credit fundamentals: The sessions generally affirmed our view that sovereign macro and credit fundamentals continue to see progress as countries in default move forward on their sovereign debt restructuring negotiations. We see more upside than downside risk on balance with many of those countries that were in focus throughout the week.

  • Turkey: During the IMF meetings, Turkey’s central bank and Minister of Finance reinforced with investors that bringing inflation down is the number one priority, above all else. From an economic standpoint, this was, in our view, the key outcome from this year’s local elections where President Erdogan’s party suffered a significant defeat. See Nuveen’s recent blog post on Turkey.
  • Zambia: The recent drought conditions were in focus which might result in some frontloading of IMF disbursements. However, more bilateral funding is needed from organizations like the World Bank. Copper production, an extremely important export for Zambia, is not expected to be impacted.
  • Pakistan: We came away more positive from the meetings as almost all import restrictions are being removed amid Pakistan’s improving current account figures. A better agricultural harvest is also reducing the need for food imports while fuel/electricity prices are moving closer to market levels. We still see decent value in terms of the bond yields, but risks remain high so are proceeding cautiously and favor a more neutral overall position while staying defensive in lower-priced bonds.

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