Our 2023 outlook for emerging-market bonds

Like their developed-market counterparts, emerging-markets (EM) bonds generally posted negative total returns in 2022 due to the rise in yields, which hit EM corporate bonds in US dollars especially hard. Between missed interest payments from Russian companies and the defaults of Chinese real-estate developers, the default rate was elevated for EM high-yield (HY) bonds in 2022, with a peak at 40.4% for Asian HY in October.

We still like clipping the high carries offered by EM investment-grade (IG) corporate bonds in US dollars, particularly Asian ones, which could benefit from China’s reopening. We expect Asian IG corporate bonds to post a positive single-digit total return this year, helped by strong carry, which should compensate for limited spread widening. Thanks to Chinese re-opening, we also see Asian credits being less exposed to contamination than other EM credits if credit spreads widen in developed markets. We therefore remain overweight EM IG corporate bonds and selective on EM HY due to recessionary risks in the US and Europe.

EM currencies’ weakness generally worsened the negative performance of local-currency EM government bonds in US dollar terms during 2022. Since we believe it is still too early to call an end to US dollar strength, we remain neutral and selective when it comes to local-currency EM sovereign bonds, but we reckon that many EM central banks could pause their hiking cycle soon. 

We expect EM local-currency sovereign bond yields to end the year slightly lower (to 6.5% from the current 6.6% seen on the JP Morgan GBI-EM Global Diversified index), although rallies in the first half of 2023 could bring yields lower. 

In line with our overall position on EM local-currency bonds, we maintain a neutral stance on Chinese sovereign bonds in renminbi as we monitor signs that the Chinese economy is indeed recovering. However, we expect Chinese bonds’ negative spread to US Treasuries to narrow as a rebound in economic growth pushes Chinese yields higher while a US recession and a pause in monetary tightening lead to a decline in US yields by year’s end. Our central forecast is for the Chinese 10-year yield to end 2023 at 3.0%, compared with 3.5% for the US equivalent.