Hello, and thank you for taking a few minutes to review some of the recent developments and key issues shaping the emerging market fixed income asset class. I am Katrina Uzun, an institutional portfolio manager responsible for overseeing Emerging Markets Debt strategies at MFS. I will start with the performance.
January got off to a strong start as everyone talked about the new administration’s plans for deregulation and tax cuts. Spreads kept tightening on talks of “US exceptionalism,” and high-yield credits outpaced investment grade. We saw impressive returns from defaulted countries like Lebanon and Venezuela, each posting returns north of 20% for the month, but also other high-yield issuers like Ecuador delivered double digit returns.
But then in February and March, investor sentiment took a turn for the worse. Concerns around tariffs and softer US macro data pushed credit spreads wider. Over the full quarter, even though spreads widened, overall returns were still firmly in positive territory at just over 2%, as you can see on the bottom left-hand side of this chart, driven by big rally in US Treasuries. Investment grade actually outperformed high yield for the quarter.
The local currency asset class outperformed hard currency assets, returning over 4% in US dollar terms. For the past decade, the dollar has been the go-to currency for investors from Europe, Japan and beyond due to its outperformance and better yields, but now, concerns about tariffs cutting into profit margins and real incomes are starting to surface. That’s raising some questions about how long the dollar strength can last, and it’s giving a boost to emerging markets local currency returns.
So what are our expectations for this year? Heading into 2025 things looked pretty encouraging: global growth was hanging in there, inflation was finally easing off (so central banks could start talking about rate cuts) and China was starting to pick up steam again. Then the US ramped up tariffs, and suddenly that upbeat storyline got a lot choppier. How much the world slows down really comes down to how big those tariffs get — and how long they stick around.
China, Canada and Mexico are the three largest exporters of goods to the US, they account for 40% of total imports, so it’s not a surprise that they were the first to be targeted in the recent tariff announcements. Our take is that most emerging markets outside of China will likely focus on negotiating first rather than immediately retaliating with their own tariffs.
When it comes to China, as you can see on this chart, Chinese exports to the US have already been declining over the recent years, while exports to emerging markets have helped support growth. Structurally, we believe China’s economy is in a better position than it was a couple of years ago, having addressed some of the structural imbalances. Before escalation in March, business sentiment was improving, the housing market was stabilizing and fiscal stimulus was effectively boosting consumption.
That said, tariffs - especially if they remain at elevated levels above 60% - pose a real headwind for the external sector and raise concerns about employment, especially among the small and medium size enterprise sectors. Additional stimulus is likely to partially offset the tariff drag, but nonetheless China’s promising recovery is probably deferred for now.
Over in Europe, Germany has unveiled a once-in-a-generation boost to infrastructure and defense spending, which could help lift euro-area growth as we head into next year. And if China rolls out fresh fiscal stimulus to offset tariff-related pressures, it could not only accelerate its own growth but the rest of the world’s too.
In that scenario, the dollar would likely cool or even dip and emerging-market assets would really benefit. It means their currencies gain strength, and their central banks get the flexibility to cut rates more aggressively, giving them room to navigate in the face of potential shocks. On top of that, lower oil prices help keep inflation contained, and combined with rate cuts, they could help boost domestic economies.
So in terms of our positioning in hard currency debt strategies, we’ve kept our defensive risk stance and overweights in double-B sovereigns — Paraguay and Costa Rica — because they have healthy balance sheets and manageable current accounts. We met with the government officials from Paraguay last week, and they confirmed their commitment to maintaining the macro prudential framework and fiscal policy and we expect the reduction in fiscal deficit to 1.5% next year. Many of these BB-rated economies are pushing through reforms that could earn them investment-grade ratings in the next few years.
We’ve dialed back our duration overweight in local currency debt portfolios and are searching for the best risk-adjusted carry opportunities. Right now, we like local rates in the Czech Republic, Poland and Mexico. On the currency front, we’re keeping a broadly neutral stance but leaning into defensive, high-carry plays — specifically the Serbian dollar, the Uruguayan peso and the Turkish lira. We met with the CB governor and Minister of Finance of Uruguay at IMF meetings, and they remain committed to maintaining monetary framework. The previous government moved to an inflation targeting regime, which was a big step for the economy, and the current government is committed to staying the course, which is good to see.
But it goes without saying that the global markets will likely remain volatile, and in this environment, it is that much more important to have a robust investment process, strong risk management and an active approach to investing.
Thank you for your time and trust in us as we continue to focus on creating value responsibly for you, our investors.
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The views expressed are those of the speaker and are subject to change at any time. These views are for informational purposes only and should not be relied upon as a recommendation to purchase any security or as a solicitation or investment advice from the Advisor. No forecasts can be guaranteed. Past performance is no guarantee of future results.
Important Risk Considerations:
The strategy may not achieve its objective and/or you could lose money on your investment.
Bond: Investments in debt instruments may decline in value as the result of, or perception of, declines in the credit quality of the issuer, borrower, counterparty, or other entity responsible for payment, underlying collateral, or changes in economic, political, issuer-specific, or other conditions. Certain types of debt instruments can be more sensitive to these factors and therefore more volatile. In addition, debt instruments entail interest rate risk (as interest rates rise, prices usually fall). Therefore, the portfolio's value may decline during rising rates. Portfolios that consist of debt instruments with longer durations are generally more sensitive to a rise in interest rates than those with shorter durations. At times, and particularly during periods of market turmoil, all or a large portion of segments of the market may not have an active trading market. As a result, it may be difficult to value these investments and it may not be possible to sell a particular investment or type of investment at any particular time or at an acceptable price. The price of an instrument trading at a negative interest rate responds to interest rate changes like other debt instruments; however, an instrument purchased at a negative interest rate is expected to produce a negative return if held to maturity.
Emerging Markets: Emerging markets can have less market structure, depth, and regulatory, custodial or operational oversight and greater political, social, geopolitical and economic instability than developed markets.
International: Investments in foreign markets can involve greater risk and volatility than U.S. investments because of adverse market, currency, economic, industry, political, regulatory, geopolitical, or other conditions.
Derivatives: Investments in derivatives can be used to take both long and short positions, be highly volatile, involve leverage (which can magnify losses), and involve risks in addition to the risks of the underlying indicator(s) on which the derivative is based, such as counterparty and liquidity risk.
High Yield: Investments in below investment grade quality debt instruments can be more volatile and have greater risk of default, or already be in default, than higher-quality debt instruments.
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The portfolio is actively managed, and current holdings may be different.
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