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Fixed income

Emerging markets perspective: Multi-dimensional views from the IMF meetings in Morocco

Katherine Renfrew
Head of Emerging Markets Corporates and Quasi-Sovereigns, Portfolio Manager
Asbjörn Friederich, CFA
Senior Sovereign Research Analyst
Dustin Benson
Senior Emerging Markets Debt Trader
IMF meetings in Morocco

This year’s annual International Monetary Fund/World Bank meeting was held in Marrakech, Morocco, from October 9-15 — the first time an African nation has hosted the event in 50 years. It was gratifying to see the country and continent receive international recognition for holding such a gathering (despite the security and logistical challenges) and for Morocco’s noteworthy focus and progress on combating climate change.

Portfolio management – Katherine Renfrew, Head of EM Corporates and Quasi-Sovereigns

As an emerging markets (EM) debt portfolio manager specializing in the corporate/quasi-sovereign sector, I have to rely on more than balance-sheet reviews and credit analyses — essential as they are — to identify attractive opportunities for our EM strategies. On the ground due diligence and macroeconomic awareness are also imperative, so traveling is an equally important component of the process.

I hadn’t been to Morocco in more than a decade, so attending the IMF meetings offered the opportunity to hear directly from central bankers, finance ministers and institutional investors as they discussed recent macro themes, economic projections and the global dynamics of the investment environment. Attending in person also provided a fresh view of Morocco, one I couldn’t get from behind my desk.

And my latest impression of this North African country was favorable. The ride from the Casablanca airport was fast and smooth, over a well-paved road with modern rest stops — a welcome change from the harrowing, traffic-snarled adventure I endured years ago. I noticed improved infrastructure, new construction and farmland marked by solar panels, indications that Morocco emerged from the Covid pandemic in reasonably good shape.

Morocco is up, Tunisia is down

Of special interest to me as a portfolio manager was Fitch’s recent affirmation of Moroccan debt at BB+ — just one rung below investment grade – based in large part on the country’s sound macroeconomic policies and comfortable liquidity buffers. Additionally, while Morocco remains a low-GDP country, its GDP per capita has doubled over the past two decades, to just over $3,500.

Not all countries in Northern Africa have fared as well. For example, Tunisia’s per capita GDP has fallen 14% since 2014 and now is just marginally above Morocco’s. Meanwhile, Tunisian sovereign debt has been downgraded this year, to CCC-. These “reversals of fortune” demonstrate that EM economic outcomes can vary dramatically, even within the same geographic region.

Based on my observations and takeaways from the meetings, I’m more comfortable with Morocco’s credit as a credit, even as concerns persist for EM debt broadly. Among these concerns are the potential escalation of geopolitical conflicts, a cloudy global market outlook heading into 2024 and the likelihood of a higher-for-longer interest rate environment. In the U.S., a possible recession and the start of the 2024 election cycle are also on my radar.

Outbreak in the Middle East demands my attention

Hamas attacked Israel a few days before the IMF meeting began, sending shockwaves through an already fraught geopolitical landscape. Markets feared that an escalation of hostilities could spill over and engulf the entire Middle East, triggering steeper energy prices and threatening global trade, since the Middle East is home to several of the world’s busiest shipping routes. Were that to happen, investor and consumer confidence would likely plummet, with riskier assets such as EM debt hit especially hard.

With the conflict unfolding in real time, I needed to immediately address whether we should adjust our exposure to Israeli debt. These holdings represented active overweights in hard currency strategies (and out-of-benchmark holdings in some portfolios). Working with Nuveen’s team of research analysts and traders, I chose to maintain, rather than reduce, our positions. Asset prices in Israel recovered after quickly selling off, suggesting that the market had initially overacted.

We’re keeping close tabs on the situation, monitoring events as they occur.

Research – Asbjörn Friederich, CFA, Senior Sovereign Research Analyst

IMF helps make the case for Morocco

I share Katherine’s cautious optimism about our holdings in Morocco. In addition to rebounding tourism and increased remittances in the wake of an earthquake that hit just a few weeks before the meeting, we expect the country to benefit from sizable increases in foreign direct investment. Also, Morocco has the trust and the backing of the IMF as shown through its approval of a $5 billion Flexible Credit Line (FCL) and access to a $1.3 billion Resilience and Sustainability Facility (RSF).

A positive backdrop for EM — with some caveats

From the vantage point of analyzing both EM and DM central banks, I believe EMD can find support from continued global disinflation, the slow unwind of U.S. dollar strength and 2024 rate cuts from DM central banks, provided some growth can be sustained. Potential headwinds could materialize from the lagged effects of tighter financial conditions and a risk-off environment in assets on the back of a hard landing in DM. Uncertainty in the macro backdrop ahead was one of the main topics throughout my discussions with policymakers and other institutional investors. A keen focus on growth and inflation trends will be key for determining portfolio positioning and ultimately generating returns as recession risks could increase.

For hard currency, many other institutional investors held similar preferences to us, favoring (1) issuers with strong fundamentals and upward credit rating trajectories, and (2) stressed or distressed countries with improving economies on a reform trajectory with backing of multilaterals. Investors also noted they are avoiding countries with weaker fundamentals and significant financing needs. A hard landing could continue to limit issuance opportunities for countries rated B and lower, as had been the case in the “higher-for-longer” yield environment through much of 2023. This dynamic should be less problematic in 2024 if core rates fall substantially and global growth holds up.

For EM local currency, we continue to favor local rates in countries where we deem the interest rate stances and guidance, adjusted for inflation projections, are too restrictive such as in countries like Hungary, South Africa and Czech Republic. A slower pace of monetary easing from Latin American central banks (Brazil, Colombia and Chile) also came up in discussions with other institutional investors in Marrakech. In general, all these central banks highlighted similar upside risks to their disinflation trajectories focusing on: 1) increases in inflation expectations, 2) food price inflation (El Nino), and 3) energy price shocks (broadening and worsening of the Israel-Hamas war).

Israel in focus

Israel was a topic of particular interest during the meetings and discussions. We agree with officials who were adamant on Israeli fiscal and external buffers being sufficient to prevent a significant deterioration in fundamentals or ratings over the medium-term. However, the economic effects from the war are expected to weigh significantly on growth through domestic demand, exports and, on the supply side, caused a significant drag on labor supply and productivity. Immediately after the war began, our base case was for a protracted conflict that would weigh on the fiscal side and cause a steepening of the local bond curve. For hard currency, we expected widening pressure but agree with officials that fundamentals are sound and therefore a rating slide (of more than 2 notches) is unlikely.

Trading – Dustin Benson, Senior Emerging Markets Debt Trader

It pays to be active

Since its inception as an investable asset class in the late 1980s/early 1990s, EM debt has grown and evolved against a global backdrop of economic, financial and political changes. These changes have created compelling opportunities and periods of challenging volatility, which we’ve experienced over the last few years. Morocco’s hosting of the IMF meetings provides a compelling narrative of the improvements we’ve seen in many EM economies we’ve invested in over the years.

What was clear during my time in Morocco was that investors clearly lacked consensus on the path ahead for rates, central bank activity and the outlook for global economic health. Most of the large-scale meetings I attended avoided commitment and came across as vague in terms of expectations for the path ahead. I believe this helps illustrate the delicacy of the coming months as market participants are absent a true “consensus” view for 2024, presenting a compelling opportunity for active investors.

One surprising element of this year’s IMF meetings was the prevalence of “fast money” and macro hedge funds, which typically rely on price speculation, rather than underlying fundamentals. Most of these speculators seemed more focused on sovereign and local markets, where scale is greatest, and very few spent time assessing deeper credit or rates opportunities. This investor group has increasingly turned to ETFs to execute trade ideas quickly and efficiently, bringing to light the rising influence of strategies that passively track benchmarks on EMD prices. However, even the broadest ETF indexes fail to capture a significant portion of the $5+ trillion in outstanding tradable EM debt, potentially “shortchanging” investors.

In our view, the unique characteristics, opportunities and risks of the asset class make it a discipline best suited to active portfolio management. As EM traders, we can see firsthand the inefficiencies that still exist in these markets and the opportunities those present. Experienced active managers can add value both by being more selective within a benchmark and by investing outside of it. Active managers are also able to employ diligent credit research and risk management tools that indexes, by definition, do not use.

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