2023 Mid-year Bond Market Outlook

A quiet bull market in EM local debt?

Brian Garvey, Portfolio Manager
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This is an excerpt from our 2023 Mid-year Investment Outlook, in which specialists from across our investment platform share insights on the economic and market forces that we expect to influence portfolios in the second half of the year. This is a chapter in the Bond Market Outlook section

After 13 years of relative underperformance, there’s now a quiet bull market occurring in emerging markets (EM) local debt. Over the past 12 months,1  EM local debt has returned 6.6% — by far outperforming the rest of the global fixed income universe (Figure 1). 

Figure 1
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Over the past 13 years, EM local debt wasn’t just “not first” among its peers, it was last. As Figure 1 illustrates, in period from January 2008 through April 2022, this asset class produced an annualized return of 1.5% with 12.5% volatility, making it the worst-performing component of global fixed income in the decade-plus since the Global Financial Crisis.

So why the remarkable change over the past year? And against a backdrop of US Federal Reserve (Fed) tightening to the tune of 475 basis points in the past year, no less? 

The major difference between this cycle and previous ones is that the majority of EM central banks acted in an unusually orthodox manner, preemptively raising interest rates well ahead of the Fed. In fact, the weighted EM central bank rate had already risen by 250 basis points by the time the Fed initiated its rate-hiking cycle in March 2022. 

Going forward, it may be reasonable to expect a period of consolidation or more muted performance in this space until it becomes clearer that the Fed rate-hiking cycle has paused. Such a pause would set the stage for the second leg of an EM local debt bull market, as we believe that most EM central banks will begin easing rates later this year. What’s more, EM inflation continues to surprise to the downside, apparently normalizing more quickly than in developed market counterparts. 

We’re optimistic that recent stronger EM local debt performance could prove to be a longer-term trend because, after 13 years of underperformance, investors in this space have become frustrated. It can take a long time to unwind this type of negative sentiment, which ultimately contributes to the creation of more enduring bull markets. It appears that a positive role reversal for EM local debt may be underway. 


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1 As of 9 May 2023


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