Emerging market local currency sovereign bonds - Update

Emerging market (EM) local currency (LC) sovereign bonds have had a tough first half of the year, mostly because of the weakening of EM currencies against both the US dollar and the euro. Nevertheless, their fortunes have started to turn in recent weeks, as market participants’ expectations for a more aggressive US Federal Fund rate-cutting cycle and weaker US economic growth have led the US dollar to weaken.

EM LC sovereign bond yields on average have recently fallen to 6.3% on the back of renewed expectations for EM central banks rate cuts and less downward pressures on EM currencies (according to the JP Morgan GBI-EM Global Diversified index on 13 August). The recent fall has been primarily driven by lower yields in Mexico, Poland, South Africa and to a lesser extent Brazil.

Looking ahead, we expect EM yields to stabilise close to current levels and have a year-end forecast of 6.4% for the JP Morgan GBI-EM Global Diversified index. This would mean that most of the total return this year would come from the carry, while further appreciation of EM currencies could be the cherry on the cake. Against this backdrop, we remain overweight EM LC sovereign bonds.