emerging markets debt 2020 outlook - hsbc global asset management · 2020-01-21 · january 2020...

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Not for further distribution.

January 2020

Emerging Markets Debt 2020 Outlook

For institutional investor and financial advisor use only.

Nor for further distribution.



Executive summary


While the Emerging Markets (EM) asset class has been impacted by a slew of negative events

in 2019, performance ended the year with impressive double digit returns across both hard and

local debt assets.

In order to assess the outlook for the EMD asset class in 2020, it is important to understand the

drivers of the strong performance this year. Global risk sentiment returned in early 2019 fueled

by attractive valuations entering the year, the more dovish tones from the Federal Reserve, a

sharp decline in US 10-year Treasury yields, a stable US dollar, and finally the ongoing trade

negotiations between the US and China with the most recent “Phase 1” deal agreement.

The outlook for the global macro environment should be marginally supportive of EM growth in

2020. We expect a slight pickup in global growth and while we have reason to be somewhat

optimistic, we do not expect a significant growth breakout. Over the past few years, inflation has

persistently fallen across DM and EM and while we do not forecast a steep rise in inflation, we

do acknowledge that the efficacy of easy monetary policy is limited and that we may be close to

the lower bound in terms of monetary easing going forward. With respect to the impact of the

US-China trade tensions on the macro environment, the recent announcement of the “Phase 1”

deal does remove some uncertainty and looking ahead there could be some updraft in growth

on account of negative output gaps. While a re-escalation of the trade war is not our base case,

it certainly remains a risk, particularly as the US heads into Presidential elections this year.

Lastly, the fundamentals in emerging market countries are a mixed picture with some of larger

economies likely to experience a decent recovery while select high yield economies will

continue to be dependent of portfolio flows in the near future.

In this article we combine these assessments with our valuation analysis to construct our thesis

for EMD assets across hard currency and local debt in 2020. Based on our outlook, we are

beginning the year with a slightly constructive view on the EMD asset class as a whole.

However, we acknowledge that the risk premium across the asset class has shrunk and is also

not uniform and we do not intend to keep our positioning static as the year progresses.



Introduction


When one considers the numerous headwinds that buffeted markets through much of 2019, the

strong performance of the Emerging Markets Debt (EMD) asset class seems even more

surprising. There were plenty of negative events throughout the year including an escalation of

trade hostilities between the US and China; a slowdown in global growth and growth

expectations; geopolitical flashpoints around the Middle East; and the rise in social unrest

across Latin America, Hong Kong, Lebanon, and Iraq. In addition, there were numerous

idiosyncratic events such as the huge financial and economic slump in Argentina following the

surprising results of the primary elections. In the face of these risks surfacing, 2019 EMD

performance was nothing short of stunning:

Impressive performance was not been limited to just EMD in 2019, for example US HY BB/B

credits returned 15.10 % (ICE BofA BB-B HY Index), US IG corporates returned 14.23% (ICE

BofA US Corporate Index), and the S&P had a 31% total return in the year. As we think about

the outlook for EMD in 2020, it behooves us to first take a look back at the main drivers of these

strong returns in 2019:

FOMC pivot – the Federal Reserve changed direction in early 2019 from a hiking bias to a

“mid-cycle adjustment” of cutting rates three times over the course of the year, which has

clearly been a very important driver for returns across asset classes

Decline in US Treasury yields – US 10-year Treasury yields declined by over 70bps in 2019

due to the downward pressure exerted by slowing global growth and negative yields across

many developed markets (DM) countries. This compression also contributed to positive

performance as exemplified in the EM hard currency sovereign return: the benchmark (JPM

EMBIG) has a duration of 7.75 years and as a result, the compression of US Treasury yields

accounted for approximately 6% of total returns for the asset class in 2019

Attractive valuations in EM – Entering 2019, valuations for EMD assets had become

inordinately cheap following the sell-off that began in Q3 2018. Sovereign spreads widened

almost 100bps during the period, resulting in very attractive valuations relative both to peers

and to historical levels. Additionally, real rates in the EM local space were enticing at almost

2% compared to -1% for the developed world at the beginning of 2019

USD stability – The USD rallied approximately 5% in trade-weighted terms (DXY) in 2018,

but was broadly stable through 2019, allowing for the removal of a significant headwind for

risk assets overall

US-China “Phase 1” trade deal – While we do believe that a long-term resolution of the

deteriorating US-China relationship is going to prove elusive in the near future [refer to our

earlier paper “Tariffs, Trade and Beyond: The US-China Challenge”], the recent

announcement of a “Phase 1” deal has reduced some uncertainty from the global economy

and markets. Since the announcement of the deal, sovereign spreads have rallied by about

40bps with HY sovereign spreads moving almost a 100bps tighter, evidence of a less

pessimistic outlook

Asset Class Index YTD USD return

Hard Currency Sovereign JPM EMBIG 14.42%

Hard Currency Corporates JPM CEMBIG BD 13.09%

Local Currency Bonds JPM GBI EM GD 13.47%

Local Currency JPM ELMI+ 5.20%

Source: JPMorgan, Bloomberg, HSBC Global Asset Management. Benchmark returns as of 31 December 2019.



EMD in 2020 – Where do we go from here?

Past performance is no guarantee of future results. Source: International Monetary Fund, World Economic Outlook Database, October 15, 2019.

G4 is China, Euro area, Japan, United States. Forecasts, projections or targets are indicative only and are not guaranteed in any way.

HSBC Global Asset Management accepts no liability for any failure to meet such forecasts, projections or targets.

Long time EM investors are keenly aware that the top-down macroeconomic environment is as

important as bottom-up country fundamentals when considering the outlook for EMD. As such,

we will assess our expectations for the macroeconomic outlook in this section across global

growth, central bank policy and global trade tensions.

Macroeconomic outlook:

A. Global Growth

We expect a slight pickup in global growth in 2020 driven by the following factors:

Trade headwinds starting to dissipate

Positive effects from monetary easing by global central banks with some lag in the real

economy

Negative output gaps beginning to shrink slightly

Countries with fiscal room starting to use some of that to support growth

In the IMF’s latest WEO (Figure 1), global growth is projected to pick up slightly to 3.4% in

2020, compared to 3% in 2019. This is expected to be driven by EM with growth picking up by

about 70bps, while DM economies slow somewhat. Among the larger EM economies, we

expect some growth recovery in countries running negative output gaps such as Brazil, Mexico,

India, South Africa and Russia.

2.5

3.0

3.5

4.0

4.5

2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024

Figure 1. GDP Growth: World and G4

World G4

GD

P



Macroeconomic Outlook – Growth

High frequency PMI data shows early signs of a small pickup in both services and manufacturing (Figure 2).

Services have clearly held up better overall, which is perhaps expected given the larger domestic component in

services in an environment where global trade has been week. While it is too early to say that the recovery in

manufacturing can be sustained through 2020, there seems to be a small upward trend.

Despite there being no shortage of pessimism as it relates to growth in EM, the chart below (Figure 3) tells a

starkly different story, demonstrating the resilience of EM manufacturing even in a fairly adverse environment,

especially when compared to DM.

46

48

50

52

54

56

58

Services PMIs

EZ Ser US Ser EM Ser China Ser

45

47

49

51

53

55

57

Manufacturing PMIs

EZ Man US Man EM Man China Man

Figure 2.

-3.0

-2.5

-2.0

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

January-12 January-13 January-14 January-15 January-16 January-17 January-18 January-19

Figure 3. Headline manufacturing PMIs (st. dev. from mean)

Developed Markets Emerging Markets

Source: Bloomberg, Markit, HSBC Global Asset Management as of 31 December 2019.



25

35

45

55

65

75

October-99 October-04 October-09 October-14 October-19

-30

-20

-10

0

10

20

Figure 7. Investment and uncertainty

Private domestic investment, yoy%(LHS)

Conf. Board CEO Confidence Index, 2Q lag(RHS)


In terms of market expectations however, data has continued to surprise lower in EM (Figure 4),

as measured by surprise indices, while Europe seems to be recovering somewhat relative to

rock-bottom expectations.

Within the EM universe though, it is interesting to note that Latin America shows an improving

trend while Asia seems to lag relative to expectations (Figure 5).

In terms of the growth outlook for the major economies of US, Eurozone and China, we find the

picture that emerges is slightly different from the headlines. In the US for example, while headline

growth seems robust and trend line, this is almost exclusively consumption led (Figure 6) while

business confidence is close to the Global Financial Crisis lows (Figure 7). This is one of the

reasons that while we are not predicting an imminent recession in the US, we do believe that the

US could underperform relative to expectations.

-150

-100

-50

0

50

100

150

January-18 August-18 March-19 October-19

Figure 4. Economic Surprise Indices

UNITED STATES EUROGlobal ChinaEMERGING MARKETS

-100

-50

0

50

100

January-18 August-18 March-19 October-19

Figure 5. Economic Surprise Indices

Latin America CEEMEA

Asia Pacific BRIC

Source: Bloomberg, HSBC Global Asset Management as of 31 December 2019.

Lowest confidence

since GFC-1

-0.5

0

0.5

1

1.5

2

2.5

3

3.5

4Figure 6. US quarterly GDP contributions

GDP ex-consumption (G + l +X - M)Personal ConsumptionHeadline GDP

2016 2017 2018 2019| | |




The Eurozone has been a clear underperformer over the year as growth has continued to be stagnant (Figure 8).

However, much of this malaise can be traced to the German manufacturing sector. While Germany has been

unwilling to employ any fiscal stimulus given their self-imposed “Black-Zero” budget, we do think that with inflation

far below target and employment starting to get impacted, there is some likelihood Germany will loosen the purse-

strings (Figures 9 & 10).


4.75

5.00

5.25

5.50

5.75

6.00

6.25

6.50

6.75

7.00

0.00

0.25

0.50

0.75

1.00

1.25

1.50

1.75

2.00

2012 2013 2014 2015 2016 2017 2018 2019

Figure 10. German labor market rolling over?

Employment % 6m annualized(LHS)

Unemployment rate %(RHS)

-0.1

0

0.1

0.2

0.3

0.4

0.5

0.6

Q1 Q2 Q3

Figure 8. Eurozone GDP growth

Germany France Spain Italy EZ

Estimate

-2.5

-2

-1.5

-1

-0.5

0

0.5

1

1.5

2

January-10 January-13 January-16 January-19

Figure 9. Manufacturing at the heart of Eurozone-Germany differential

PMI manufacturing new orders

(st. dev. from mean)

Eurozone

ex-Germany

Germany




In China, we are seeing some improvement in domestic conditions given the recovery in imports while the consumption sector

continues to be fairly resilient. Infrastructure investment is clearly weaker though some pickup should be expected from policy

support going forward. Policy makers have flexibility as core inflation is well contained and stable. As such, while we do not expect

a sharp growth spurt, we do expect growth in China to be resilient and on a slightly improving trend (Figures 11-14).

Growth Summary

Looking at the global growth picture, we have reason to be slightly optimistic for 2020 though we do not expect a signficant growth

breakout .

4

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6

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8

9

10

11

12

-20

-10

0

10

20

30

40

50

Jun 14 Jun 15 Jun 16 Jun 17 Jun 18 Jun 19

Figure 13. China: select consumption-related indicators

NBS online retail sales - goods & services (LHS)Passenger car sales volume (LHS)Real retail sales (RHS)

% yoy % yoy

-8

-3

2

7

12

-1

0

1

2

3

4

5

6

7

Jan 10 Jan 12 Jan 14 Jan 16 Jan 18

Figure 14. China: inflation readings

Headline (LHS) Core (LHS)Service (LHS) Food (RHS)PPI (RHS)

-15

-10

-5

0

5

10

15

20

25

30

Jan 14 Jan 16 Jan 18

Figure 12. China: fixed asset investment (FAI): infrastructure

Power and utility Infrastructure (NBS)

% yoy (ytd)

% yoy % yoy

Source: Macrobond, Bloomberg, HSBC Global Asset Management as of 31 December 2019.

60

70

80

90

100

110

Jan-13 Jan-15 Jan-17 Jan-19

Figure 11. Domestic demand improving, albeit slowly

China – ordinary imports (USD bn, SA)

3 month

moving average



Macroeconomic Outlook – DM Central Bank Policy

B. DM Central Bank Policy

In the past few years, inflation has continued to fall across DM and EM, as has inflation volatility (Figures 15 & 16). This has

permitted central banks to keep policy mostly accommodative. Over the course of 2019, inflation has mostly undershot inflation

targets (Figure 17).

-4

-2

0

2

4

6

8

10

12

14

Dec-80 Dec-86 Dec-92 Dec-98 Dec-04 Dec-10 Dec-16

Figure 15. Inflation in DM in % y/y(Euro area before 1997 based on aggregation from

country data using PPP GDP as weights)

US Euro Area Japan

0

5

10

15

20

25

Jan-00 Jan-03 Jan-06 Jan-09 Jan-12 Jan-15 Jan-18

Figure 16. Standard deviation of inflation by country group

Emerging markets Developed markets

-2.5

-2

-1.5

-1

-0.5

0

0.5

1

US Can UK EZ Kor Jpn Aus Tha Mex ZAF Bra Chn

Latest core inflation

pp deviation in y/y inflation from target

2% target 2.5% target

3% to 4.5% target

Dec 18 core inflation

Figure 17. Missing the target

Source: IIF, Bloomberg, HSBC Global Asset Management as of 31 December 2019.



Macroeconomic Outlook – DM Central Bank Policy

& Global Trade Relations

Looking to 2020, while we do not forecast a steep rise in inflation, we acknowledge that the efficacy of easy

monetary policy is limited going forward and we may be close to the lower-bound in terms of monetary

easing. Additionally, markets seem to be pricing in cuts and, in the unlikely event central banks are more

dovish than expected, we believe this would be the result of an environment of very weak growth.

Therefore, we do not believe we will see a similar lift for risk assets from policy rates in 2020.

C. Global trade tensions or Deglobalization

US-China trade tensions resulted in about 0.7% drag to the global economy and about 0.5% for the US

economy in 2019 according to estimates from Bank of America. As previously mentioned, while we do not

believe that a full resolution will be forthcoming in 2020, the announcement of the “Phase 1” trade deal

certainly does lift some of the uncertainty from the macro environment. As such, there could be some

momentum in growth in 2020 beyond the cyclical lift resulting from negative output gaps. While a re-

escalation of the trade war is not our base case, it certainly remains a risk, particularly as the US heads into

Presidential elections. There is a small likelihood that a polarized political climate in the US could lead to a

hardening of positions, particularly as the view of an increasingly adversarial relationship with China seems

to be shared on both sides of the aisle. Broadly speaking, ironically enough, the trend toward nationalism

and protectionism seems to be a global phenomenon that we do not feel will reverse any time soon. Clearly,

this does not augur well for EM economies.

Putting together the various pieces of the global macro environment, we conclude that this should be

marginally supportive of EM growth this year, though it is hard to see a “V-shaped” recovery. While we think

that a combination of these factors should support EMD assets in the first half of the year, we should

temper our expectations of very strong performance.

AMER Policy RateEffective

RateBasis

3/31/203M

6/30/206M

9/30/209M

12/31/2012M

USD 1.63% 1.55% -0.08% 1.63% 1.58% 1.53% 1.49%

CAD 1.75% 1.78% 0.03% 1.68% 1.65% 1.63% 1.66%

MXN 7.25% 7.56% 0.31% 6.93% 6.61% 6.44% 6.31%

EMEA Policy RateEffective

RateBasis

3/31/203M

6/30/206M

9/30/209M

12/31/2012M

EUR 0.00% -0.45% -0.45% 0.00% -0.01% 0.00% 0.01%

GBP 0.75% 0.71% -0.04% 0.72% 0.67% 0.64% 0.63%

PLN 1.50% 1.71% 0.21% 1.47% 1.46% 1.45% 1.54%

ZAR 6.50% 6.80% 0.30% 6.31% 6.24% 6.19% 6.20%

TRY 12.00% 11.02% -0.98% 12.48% 12.92% 13.31% 13.64%

RUB 6.25% 6.45% 0.20% 6.34% 6.23% 5.97% 6.06%

APAC Policy RateEffective

RateBasis

3/31/203M

6/30/206M

9/30/209M

12/31/2012M

CNY 4.35% 3.00% -1.35% 4.45% 4.49% 4.52% 4.56%

JPY -0.07% -0.05% 0.02% -0.06% -0.06% -0.06% -0.06%

INR 5.15% 5.24% 0.09% 5.18% 5.13% 5.08% 5.20%

Figure 18. Market implied rates




Emerging Market Fundamentals

EM fundamentals have shown mixed trends across various metrics over the past year. On the whole, growth and activity

have held up reasonably well given the external environment, as noted earlier. In fact, we believe that the growth

differential between EM and DM will continue to widen in EM’s favor in the year ahead, which should support demand for

the asset class (Figure 19).

Overall EM countries have held up well on metrics such as external debt to GDP ratio, which has stabilized; budget and

currency account balances, which are on an improving trend; and import coverage, which is healthy and improving

(Figures 20 & 21).

Additionally, the credit quality of the EM universe improved in 2019 with the inclusion of higher-income Gulf Cooperation

Council (GCC) economies in EM external debt indices (JPM EMBI). Many of these economies have experienced an

improvement in their economic metrics as oil prices recovered somewhat in 2019.

Past performance is no guarantee of future results. Source: International Monetary Fund, Haver, HSBC Global Asset Management,

December 31, 2019. Forecasts, projections or targets are indicative only and are not guaranteed in any way. HSBC Global Asset Management accepts no

liability for any failure to meet such forecasts, projections or targets.

% b

udget

bala

nce o

f G

DP

-4

-3.5

-3

-2.5

-2

-1.5

-1

-0.5

0

0.5

Figure 20. Budget balances are on improving trend

Govt/Budget Balance % of GDP

Exte

rnal debt

% o

f G

DP

-3

-2

-1

0

1

2

3

4Figure 21. EM current accounts have

stabilized

CA Balance



Emerging Market Fundamentals

On the other hand, there has also been a deterioration in some fundamentals, including the overall levels of debt. This

has been enabled by the abundant availability of cheap financing on account of DM central bank largesse (Figure 22).

Idiosyncratic stories in the lower-rated EM countries caused concern in 2019, led by Argentina. In the first half of 2019,

Argentina began to show improvements in terms of inflationary dynamics as well as a more orthodox mix of economic

policy. However, this was thrown off-course following the surprising results in the primary elections in August 2019 and

the subsequent election of the opposition candidate Alberto Fernandez to the Presidency. New policy indications so far

do not justify the extremely pessimistic market pricing following the election, but the fact remains that Argentina requires

debt relief to achieve a sustainable fiscal path. Furthermore, macroeconomic policies will need to walk a fine line between

supporting growth in the domestic economy and satisfying global capital markets to which Argentina must maintain

access.

Lebanon is another economy with significant challenges. The country is running double-digit twin deficits and has recently

seen its existing governing structure face extraordinary challenges. At this point, there does not seem to be a clearly

identifiable political path going forward with the country split along sectarian lines and facing a significant credibility deficit

among market participants. In the absence of foreign currency inflows, it is very hard to see how Lebanon can support its

massive debt burden, which is why we remain underweight the country.

15

25

35

45

55

65

75

85

95

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

2018

2019

Figure 22. Debt levels have risen

Households Debt % GDP Government Debt % GDP

Non-Financial Corp Debt % GDP

Debt

/ G

DP

(%

)

Source: IIF, HSBC Global Asset Management as of 31 December 2019.



Emerging market fundamentals

Another area to watch for is the single B-rated sector in EM, where fundamentals have been mixed at best. While there

has been some fiscal consolidation over the past few years, growth has been uninspiring and interest expense as a

percentage of revenue has grown sharply given the large amount of issuance highlighted earlier (Figures 23-26).

Other key factors that will impact EMD in 2020 include policy reforms and social unrest. One positive point for EM

countries is the likelihood of meaningful structural reforms going forward. These began in 2019, with the pension system

reform in Brazil, which helped ensure long term fiscal stability, as well as reforms in Ukraine and Egypt. There had been

hope of long-term reforms in Argentina, which was waylaid in a spectacular fashion as voters rejected such severe

austerity in the midst of a deep recession. We do believe that there is potential for further reforms, especially in Brazil

where the reform agenda remains very ambitious including administrative reform to cut expenditures and tax reform.

Similarly, South Africa is in need of dire structural reforms, including a resolution of a possible land appropriation bill and

reforms related to the state-owned utility company, Eskom. In both India and Indonesia, there is a recognition of the need

for labor reform. It would be foolhardy to believe that all such reforms can be accomplished in 2020, but given the

urgency in certain circumstances, we are cautiously hopeful some progress will be made.

In 2019, we saw a meaningful escalation in social tensions across countries, which presents a risk to passing unpopular

reforms thus aggravating the situation even further. We feel this risk is especially elevated across a wide variety of

countries including Turkey, India, Brazil, Colombia, Argentina, South Africa and Egypt due to a combination of

demographic and economic factors. As a result, we have tempered our enthusiasm for meaningful reform that could lift

the long-term trajectory for countries.

Fundamentals Summary

Overall, macroeconomic fundamentals in EM are a mixed bag with some of the larger economies set to show a decent

recovery and frontier or frontier-like economies continuing to be dependent on portfolio flows in the near future. A growth

pick up in 2020 would likely lead to a marginal improvement in these fundamentals.

-

1

2

3

4

5

6

7

8 Figure 23. GDP Growth %

GDP Growth % Avg

10%

12%

14%

16%

18%

20%

22%

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

2018

2019

Figure 24. Int Exp % of Rev

Int Exp % of Rev Avg

40%

45%

50%

55%

60%

65%

70%

75%Figure 25. EXD % of GDP

EXD % of GDP Avg

10%

12%

14%

16%

18%

20%Figure 26. Reserves % GDP

Reserves % GDP Avg

Source: Haver, HSBC Global Asset Management as of 31 December 2019.



Expectations across EMD Sectors – Hard Currency

To construct our outlook across EMD sectors for 2020, we have combined our assessment of macro-events and

economic fundaments with our expectations for valuations.

Hard Currency Sovereigns

Spreads on EM hard currency sovereigns compressed by almost 150bps in 2019 (JPM EMBIG), with the IG sector

tightening by approximately 80bps while the HY sector experienced 220bps of spread tightening, though excluding

Argentina and Venezuela the spread compression was only 70 bps. At current valuations, we do not believe IG spreads

offer much value with a few exceptions, such as Mexico and Saudi Arabia where we believe further outperformance is

warranted. In addition to IG valuations appearing expensive relative to historic levels, when compared to peers in DM,

they do not seem particularly attractive (Figure 27).

In HY, particularly in the BB-rated segment, we believe there is room for further spread compression, especially when

compared to peers in DM. In the BB-rated space for example, EM credits provide close to a 80bps premium in spread

compensation compared to the average 20bps over the last five years (Figure 28). In the single B-rated space, we do not

find valuations particularly compelling, with only a few exceptions.

Our overall stance in EM hard currency is slightly constructive with an expectation for some spread compression,

focused in the HY sector.

0

20

40

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100

120

140

Dec-13 Dec-14 Dec-15 Dec-16 Dec-17 Dec-18

Figure 27. EM IG vs US IG

EM IG - US IG Average

-150

-100

-50

0

50

100

150

Dec-13 Dec-14 Dec-15 Dec-16 Dec-17 Dec-18

Figure 28. EM HY BB vs US HY BB

EM BB - US BB Average

Source: JP Morgan, BofA Merrill Lynch, Bloomberg, HSBC Global Asset Management as of 31 December 2019.

Spre

ad d

iffe

rentia

lS

pre

ad d

iffe

rentia

l



Expectations across EMD Sectors – Local Currencies

Local currency debt

A) Local Currencies

In the local currency space, we find overall valuations to be slightly attractive, but not particularly cheap as measured by

REER (Figure 29). Compared to other EMD sectors, the 2019 performance of EM currencies was somewhat

underwhelming as currencies were actually marginally weaker on a spot basis, and the positive return was driven by the

carry on these currencies.

When analyzing the long-term evolution of REERs (Figure 30), it does seem that the USD is overvalued and would

therefore justify a long EM FX position. However, there is a key risk of further episodes of risk aversion in the market

which would cause a safe haven bid for the USD.

Within the EM FX asset class, there are currencies that are currently screening as cheap which should benefit from

improving terms of trade and outperform. Among these we favor certain currencies including the Brazilian real, Mexican

peso, Russian ruble and Indonesian rupiah. We also have a preference for the Polish zloty as a proxy for the EUR, which

we believe to be undervalued relative to the USD. The EM currencies we feel are expensive or overvalued include the

Singapore dollar, Taiwanese dollar, Israeli shekel and Romanian leu.

Going forward, we believe that in order for EM FX to outperform meaningfully, there needs to be a generalized

debasement of the USD given the long-term correlation between the DXY and EM FX spot rate (Figure 31).

60.0

80.0

100.0

120.0

140.0

January-10 January-13 January-16 January-19

Figure 30. Developed Markets REERs(rebased to 100)

USD REER EUR REER JPY REERUSD Avg EUR Avg Jpy Avg

80

85

90

95

100

105

October-02 October-07 October-12 October-17

Figure 29. EM REER ex Argentina

EM Real Effective Exchange Rate ex Argentina5-year average REER

y = -0.525x - 0.0643

-6

-5

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-2

-1

0

1

2

3

4

-3 -2.5 -2 -1.5 -1 -0.5 0 0.5 1 1.5 2 2.5 3 3.5

JP

M E

MC

I F

ixin

g

DOLLAR INDEX SPOT

Figure 31.

Source: JP Morgan, Bloomberg, HSBC Global Asset Management as of 31 December 2019.



Expectations across EMD Sectors – Local Rates

B) Local Rates

Next looking at local rates, we believe that it is highly unlikely there will be a repeat of 2019 where local yields fell

drastically. The decline in EM inflation from about 4.1% to about 3.2% through the year, along with a dovish Fed, allowed

EM central banks to ease rates considerably in 2019, thus contributing to the 120bps rally in EM rates. Real yields (yield

minus inflation) in EM declined from 2% to 0.9 % over 2019. The real yield differential versus DM continues to be stable,

however, it is hard to see that contracting further as we believe EM countries need to maintain an attractive differential to

attract portfolio flows (Figure 32).

EM local rate curves continue to be fairly steep, providing a potential benefit from the roll down effect. Overall we are

neutral on the local rates space, but within the sector, we prefer being long rates in Mexico and Indonesia where real

rates are close to their historic wides. In addition, we currently find South Africa rates attractive given the steepness of the

curve, but this is a more tactical position as we acknowledge the overhang of a possible downgrade to HY which could

lead to outflows. In countries where real rates are extremely negative, like Poland and Hungary, we are underweight local

rates, which provides an efficient way to hedge our long rates exposures.

57

58

59

60

61

62

63

64

65

Figure 32. Inflation surprise index

-6

-5

-4

-3

-2

-1

0

1

2

3

4

5

6

7

8

141516171819202122232425262728 Figure 33. EM real yield historic ranges (since 2011)*

Real Y

ield

(%

)

*Based upon JPM GBI-EM Global Diversified.

Source: JP Morgan, Bloomberg, HSBC Global Asset Management as of 31 December 2019.



Conclusion

Entering 2020, we have a slightly constructive view on the EMD asset class. However, we

acknowledge that the risk premium across the asset class has shrunk and is also not uniform.

Therefore, we do not intend to keep our positioning static as the year progresses. Should we

see further compression in risk premiums, we will look to reduce our positions and possibly

move defensive if the valuation pendulum swings to extremely tight levels. Finally, we do not

pretend to have a crystal ball for the global economy and will continue to monitor markets and

dynamically adjust our positioning to deliver strong risk-adjusted returns for our clients.



Key Risks

There is no assurance that a portfolio will achieve its investment objective or will work under all market conditions. The value of

investments may go down as well as up and you may not get back the amount originally invested. Portfolios may be subject to

certain additional risks, which should be considered carefully along with their investment objectives and fees.

Exchange Rate Risk Changes in currency exchange rates could reduce or increase investment gains or investment losses, in

some cases significantly.

Counterparty Risk The possibility that the counterparty to a transaction may be unwilling or unable to meet its obligations.

Liquidity Risk is the risk that a Fund may encounter difficulties meeting its obligations in respect of financial liabilities that are

settled by delivering cash or other financial assets, thereby compromising existing or remaining investors.

Operational Risk may subject the Fund to errors affecting transactions, valuation, accounting, and financial reporting, among

other things.

Derivatives Risk Derivatives can behave unexpectedly. The pricing and volatility of many derivatives may diverge from strictly

reflecting the pricing or volatility of their underlying reference(s), instrument or asset.

Emerging Markets Risk Emerging markets are less established, and often more volatile, than developed markets and involve

higher risks, particularly market, liquidity and currency risks.

Interest Rate Risk When interest rates rise, bond values generally fall. This risk is generally greater the longer the maturity of

a bond investment and the higher its credit quality.

Default Risk The issuers of certain bonds could become unwilling or unable to make payments on their bonds.

Credit Risk A bond or money market security could lose value if the issuer’s financial health deteriorates.

CoCo Bond Risk Contingent convertible securities (CoCo bonds) are comparatively untested, their income payments may be

cancelled or suspended, and they are more vulnerable to losses than equities and can be highly volatile.

Past performance is no guarantee of future results.

This document is for information only and does not constitute investment advice, a solicitation or a recommendation to buy, sell or subscribe to

any investment. It is not intended to provide and should not be relied upon for accounting, legal or tax advice.

The views expressed were held at the time of preparation and are subject to change without notice.

Forecasts, projections or targets are indicative only and are not guaranteed in any way. HSBC Global Asset Management accepts no liability for

any failure to meet such forecasts, projections or targets.

Index returns assume reinvestment of all distributions and do not reflect fees or expenses. You cannot invest directly in an index.

HSBC Global Asset Management is the marketing name for the asset management businesses of HSBC Holdings Plc. HSBC Global Asset

Management (USA) Inc. is an investment adviser registered with the US Securities and Exchange Commission. HSBC Global Asset

Management (USA) Inc. serves as the investment adviser to the HSBC Funds. Foreside Distribution Services, L.P., member FINRA, is the

distributor of the HSBC Funds and is not affiliated with the adviser. HSBC Securities (USA) Inc., member NYSE, FINRA and SIPC, is a sub-

distributor of the HSBC Funds. Affiliates of HSBC Global Asset Management (USA) Inc. may receive fees for providing various services to the

funds.

HSBC Global Asset Management has based this material on information obtained from sources it believes to be reliable but which it has not

independently verified. HSBC Global Asset Management and HSBC Group accept no responsibility as to its accuracy or completeness.

Portfolio characteristics, including position sizes and sector allocations, among others, are generally averages, are only for illustrative purposes,

and do not reflect the investments of an actual portfolio unless otherwise noted. The investment guidelines of an actual portfolio may permit or

restrict investments that are materially different in size, nature and risk from those shown.

The contents of this document are confidential and may not be reproduced or further distributed to any person or entity, whether in whole or in

part, for any purpose without prior written permission.

© Copyright 2020. HSBC Global Asset Management. All rights reserved.

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emerging markets debt 2020 outlook - hsbc global asset management · 2020-01-21 · january 2020...

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