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The emerging markets (EM) local debt sector (as measured by the JP Morgan Government Bond Index – Emerging Markets Global Diversified) just posted its worst calendar-year performance since 2013, returning -8.75% against the headwind of higher EM local interest rates. The underlying culprit? EM inflation surprised to the upside in 2021, forcing a number of EM central banks to raise their policy interest rates in an effort to curb the impact.
Although overall EM inflation did not look materially different from that of the developed world last year, the policy response as of this writing has been starkly different: EM central banks as a group have hiked policy rates aggressively, whereas the US Federal Reserve (Fed) and other developed market counterparts have scarcely budged rates from the zero-bound range (Figure 1). So what now?
Many clients have asked us lately if the EM local debt sector’s poor recent performance is likely to persist through 2022. We don’t have a crystal ball of course, but there are good reasons to believe elevated EM inflation (and by extension, rising EM local rates) may prove to be more of a transitory — less “sticky” — phenomenon than in the developed world:
While there are still many unknowns on the horizon for 2022, two things seem fairly certain from our perspective: 1) EM local assets are generally under-owned by global asset allocators; and 2) there appears to be a healthy amount of skepticism already priced into many of these assets. Accordingly, we believe now may be an opportune time for discerning investors to seek out attractive entry points into some EM local debt markets.