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Past the peak and into the fire: Emerging Markets Debt built to endure the year of the dragon’s heat

Katherine Renfrew
Head of Emerging Markets Corporates and Quasi-Sovereigns, Portfolio Manager
Melissa Zaccagnino
Associate Portfolio Manager
Aaron Enriquez
Senior Research Analyst
Volcano with lava

The 2024 Nuveen Global Investment Committee (GIC) highlighted continued macro uncertainty but noted a favorable shift for fixed income investors. We echo the GIC’s approach which advocates for a flexible, diversified multi-sector approach. Given EMD’s depth and unique characteristics, the asset class has the moxie to withstand the Dragon’s heat.

Emerging Markets Debt is not a monolith: Given 2024’s uncertain trajectory, it’s worth reminding that EMD’s three sub-asset classes provide a comprehensive investible universe that can ride through the heightened volatility that have become a fixture in markets over the last few years.

  • EM Sovereigns: Provide duration exposure with a 50/50 IG/HY split and includes distressed/defaulted issuers
  • EM Corporates: Attractive carry with higher rating profile (60/40 IG/HY), more diversified geographic mix, ample spread to comparably rated sovereigns, and shorter duration
  • EM Local Markets enhanced carry and alpha potential through EMFX and domestic rate cutting cycles

EM (ex-China) Growth is heating up: While DM economies are projected to decelerate in 2024 and Chinese growth is expected to remain muted, the IMF projects EM economic growth to accelerate as those countries turn the corner from a difficult 2022-2023. Using the EMBI Global Diversified and the IMF’s latest projections, the index-weighted average GDP growth is expected to accelerate +0.7pp to 3.3% in 2024. This compares to Advanced Economies (*per IMF WEO) which are expected to decelerate by 0.1pp to 1.4%.

Meanwhile, on the fiscal side, we see the index-weighted fiscal deficit narrowing to -2.6%/GDP in 2024 (vs -2.8%/GDP in 2023), allowing for overall debt/GDP to fall to 56.2%/GDP (vs 112%/GDP for Developed markets). This view is echoed by credit ratings which are starting to see more balanced upgrades and downgrades in 2023 and positive Outlooks now outweighing Negative outlooks going into 2024.

Stressing over distressed?: Among distressed credit we continue to see a muddle-through scenario with lower default risk in 2024 when compared with 2022-2023. Meanwhile, in the defaulted segment of the sovereign space (3% of index), we saw meaningful progress in 2023 with Suriname being the first to exit default in December. We are cautiously optimistic for additional resolutions in 2024, with each exit providing a more definitive framework for future restructurings.

Keeping calm and carrying on in EM local and corporates: EM corporates provide attractive carry given higher ratings and still healthy spreads over comparable sovereigns and lower net leverage than DM peers. Furthermore, their shorter duration profile provides a nice barbell opportunity with the longer duration EMBIGD (in line with the GIC’s recommendation for a longer duration stance).

As flagged in Shop Local, EM central banks were well ahead major central banks in this hiking cycle. That early medicine is now paying off with inflation falling, providing room for earlier rate cuts from EM central banks.

No Money? No Problem: In 2023, EM hard currency returned 11% while EM local currency returned 12%. This return was notable in the context of heightened treasury volatility but also amid -$34bn of fund outflows from the asset class (following -$90bn of outflows in 2022). EM was able to shrug this off due to: 1) stronger financial commitment from International Financial Institutions, but also 2) 2023 net supply being one of the lowest in years. We see this trend of lower net supply continuing in 2024 with JPMorgan seeing negative net supply for BOTH sovereigns and EM corporates. Going back to the flows – after two years of sizeable outflows, positioning is significantly cleaner now with cumulative fund flows now back to 2019 levels.

What keeps us awake at night: Again, there is significant uncertainty in the macro outlook for 2024, with risk of inflation’s reacceleration on one end of the risk spectrum U.S. recession on the other. These concerns will only be compounded by the largest election year in history, with half of the world’s population going to the ballot boxes. Most notable for the asset class will be elections in India, Indonesia, South Africa, and Mexico but Presidential and/or Parliamentary elections will also be held in 16 other EM issuers. And of course, there’s the US elections in November.

That being said, emerging markets have withstood a commodity crash, a global pandemic, a slowing China, and the largest hiking cycle in decades. Uncertainty and volatility have become constants in emerging markets and despite a handful of defaults, the asset class has shown a maturation and resiliency over the last few years. Nuveen’s EMD team has been along for the ride since the beginning. Having navigated all forms of markets, choppy markets ahead provide ample opportunity to execute on Nuveen’s strong fundamental views and uncover strong relative value opportunities, while avoiding those downside risk scenarios, across the EMD spectrum.

Nothing can keep us awake at night if we never go to sleep!

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