Local debt: attractive carry

Moreover, many Central Banks adopt a more dovish tone following the recent and strong appreciation of the greenback. Hungary, Chile, Romania, Turkey and most Asian Central Banks are typical examples of this trend. Our biggest conviction is the Indian local debt. The Central Bank is easing its monetary policy and, in the meantime, the fundamental indicators are improving with declining inflation, partially because of the cheaper commodities. Furthermore, the carry remains appealing. On the other hand, we have negative biases on Czech and Malaysian debt, given the low level of their carry. That is not the case for South Africa and Brazil which display high carry. But, given the rise in inflation pressures, we consider that their debt is not attractive enough for the time being.

The risk premium correction reveals opportunities in the EM external debt space

The external debt displays attractive features with a spread versus US Treasuries currently back at 370 bps. We consider this spike in spread as a good buying opportunity in a low yield environment (Chart 5). We expect a spread-tightening large enough to fall below 300 bps before year-end on the back of robust growth data and low debt/GDP ratios. Technical factors are also positive drivers. Firstly, flows should again be positive this year, keeping to the trend of H2 2014. Secondly, the lack of net new supply (i.e., new issues minus redemptions) will trigger a search for attractive risk/return issues.

We search for bonds with interesting carry relative to their peers. For instance, we prefer euro issues from Croatia as the yield is more rewarding compared to comparable issues with similar risk profiles, such as Serbia. The Moroccan issue denominated in euro offers an additional yield of more than 50 bps relative to the dollar one (chart 6).

Forex: overall still cautious

We favour currencies with good reform momentum such as INR, the reforms in India are still on-going and have started to bear fruit. There is still room in the reversal trend for a large retracement.

We also like “low-beta” currencies. First, the KRW is a hedge in cases of risk aversion due to the strong current account and high FX reserves of South Korea. Second, we overweight the CNY, as we consider that the depreciating trend of this PBOC-managed currency has come to an end. Our current cautious stance on emerging currencies is also translated by our long positioning on USD as the upcoming US rate-normalisation process should further support the USD.

We remain underweight on commodity-linked currencies such as NGN and the PEN, whose Central Banks could be forced to soften their monetary policy in order to preserve their competitiveness However, our view on this kind of currencies is less pessimistic than earlier as the downside potential has been significantly reduced now.