We expect a favorable environment for emerging-market bonds in 2024, provided investors stay selective.
Despite high interest rates, geopolitical instability and sluggish economic growth in China, emerging-market bonds posted strong returns in 2023. While some headwinds may continue in 2024, we expect accommodative monetary policy, declining inflation and a weaker US dollar to provide support for the sector. Here’s how.
Fiscal Conditions Are Improving
After decelerating in line with developed-market peers in 2023, we expect economic growth in the developing world to stabilize and outpace developed markets in 2024 (Display), providing a potential boost to emerging-market bonds. Federal Reserve rate cuts over the coming year may contribute to easier global financial conditions, while declining inflation should allow emerging-market central banks to continue easing monetary policy.
But it’s the fiscal outlook that deserves a closer look. In our analysis, emerging-market fiscal conditions, which have suffered in aggregate during recent years, may begin to recover in 2024, particularly in countries with lower-rated sovereign debt. The fiscal picture should improve for distressed sovereigns like Argentina and Ukraine—welcome news for investors after recent disruptions in lower-rated sovereigns. We also expect several other countries, including Nigeria and Turkey, to follow through with structural reforms. Cleaner fiscal slates could provide better access to debt markets and pave the way for sovereign credit rating upgrades.
In fact, we forecast fiscal stability or improvement in 2024 for more than 70% of the countries we track in the emerging-market universe. We believe countries that can effectively balance fiscal and monetary policy are likely to outperform. Colombia, Hungary and Indonesia are among the large, liquid sovereigns where fiscal stability and consolidation could provide a market-friendly complement to monetary easing over the year ahead.
Moderating Headwinds and Growing Tailwinds
Because China exercises huge sway over emerging markets, much has been made of its economic slowdown as a headwind to emerging-market debt. We think the bellwether nation’s prospects for the coming year are mixed.
While China’s beleaguered property sector continues to hamper growth, policymakers have stepped up stimulus. That should be enough to make the country’s growth trajectory neither a driver of nor a drag on emerging markets in 2024, in our view. But policymakers’ ongoing efforts will require walking a tightrope, with further policy accommodation needed to maintain a delicate equilibrium.
There is a silver lining: moderating growth in China provides opportunities for other large emerging-market countries, such as India, to help fill the void. In fact, India tops our 2024 global growth forecasts.
Meanwhile, technicals have emerged as a growing tailwind for the emerging-market debt sector. Issuance has been well below historical averages for two years running, and corporate net issuance has trended into negative territory. At the same time, the sector has seen major outflows, with 2022 and 2023 suffering the two largest annual outflows on record.
Limited issuance coupled with significant outflows has resulted in the asset class being under-owned, in our view. Those technical conditions are highly supportive for our outlook in 2024, because inflows have historically followed strong returns.
Local-Currency Debt: Whither the Dollar?
Local-currency debt is influenced by exchange rates, and the US dollar has looked fundamentally overvalued for some time now, in our analysis. With more accommodative US monetary policy on tap for 2024, we believe this overvaluation will gradually unwind, potentially providing support for emerging-market local bonds. We think this is most likely to occur in thesoft-landing scenario we anticipate.
Either way, the prospects for local-currency assets could once again hinge on the relative strength of the US dollar, which has seen a lot of variation over the past 40 years (Display).
While we expect a weaker dollar in 2024, the dollar finished 2023 down only marginally. If the dollar’s correction remains slow and volatile, investors will need to be creative about hedging strategies. This is best left to active managers, who can deploy dynamic foreign-exchange hedging to offset currency volatility.
Stay Active in the Face of Risks
2024 promises to be a consequential year for elections. In addition to US elections in November, upcoming elections in South Africa, Panama, Mexico and a number of other countries could move markets. To be sure, political uncertainty is rarely an investor’s friend, but with an otherwise supportive environment for emerging-market debt, we believe politics are unlikely to disrupt global growth or inflation trends.
That isn’t to say surprises won’t be in store. They could take any number of forms, from a stronger-than-expected US economy to geopolitical flare-ups. But keep in mind that 2023 was full of surprises, including the failure of a handful of US regional banks, and emerging-market bonds still generated strong returns. We think 2024 could be similar. That’s yet another reason to stay active: active managers can dynamically maneuver investors through this uncertainty.
While we anticipate more accommodative monetary policy in 2024, policymakers in developed markets won’t necessarily cut rates as quickly as they’ve been able to in previous cycles. Moreover, investors may disagree with the Fed about the timing and magnitude of rate cuts in 2024, just as they did last year. This could lead to bouts of market volatility, as well as opportunities for active managers to take long-term positions at attractive prices.
Nonetheless, we foresee a constructive environment for emerging-market bonds in 2024, provided investors stay selective. Emerging-market bonds represent an enormous asset class with considerable diversity. As always, it will be important for investors to carefully pick their spots and judiciously allocate assets.
