The backdrop was supportive for emerging markets (EM) debt in August, as Treasuries rallied and commodities stabilised. Local currency debt outperformed, returning 1.79% and bringing year-to-date returns to 14.67%, as EM currencies advanced against the dollar. EM sovereign dollar-denominated debt similarly returned 1.77% for the month, outperforming corporate dollar debt, which returned 0.96%. Sovereign dollar-denominated debt has outperformed corporate dollar-denominated debt this year, with returns of 8.98% and 6.86%, respectively. The asset class continued to benefit from inflows across hard, local and blended currency funds, totaling $4.38bn for the month and $51.82bn this year. New issuance in August totaled $19.2bn with the majority issued by corporates.
Looking at the Individual asset classes
EM sovereign dollar debt returned 1.77% in August on the back of stronger Treasuries and modest spread tightening. EMBI spreads ended the month at 300 bps, 4bps tighter on the month and 42bps tighter on the year. August marked the second best month in the past 12 for EM sovereign dollar debt, trailing only February of this year, as 65 of the 66 countries represented in the index posted positive returns.
Argentina and Mexico were the largest contributors to index performance in August. After underperforming in May and June, Argentine assets have recovered in recent months on the backs of improved economic growth and better-than-expected performance of the reform-oriented, ruling coalition in the August primary mid-term elections. Mexico benefited from the perception that NAFTA renegotiations will not be as punitive as had been expected earlier in the year. Mexico has also broadly benefited from stronger-than-expected economic growth in the second quarter and from an improvement in US growth, higher industrial production and consumer demand. Venezuela was again the largest detractor from index performance during the month as the market is increasingly pricing in the potential for default.
Corporates
EM dollar corporate debt returned 0.96% in August, underperforming EM sovereign debt but outperforming US and EU corporate debt. Corporate index spreads ended the month at 295bps, 7bps wider on the month but 18bps tighter on the year.
The commodities sectors led within the corporate space. Oil and gas returned 1.76% during the month as a number of producers announced strong second quarter results, while metals and mining returned 1.52%, as the surge in metal prices continued in August. The consumer sector was the worst performing, returning -0.49% during the month. Consumer returns were dragged down by Teva Pharmaceuticals, which represents nearly 30% of the consumer sector.
Local Currency Debt
General dollar weakness relative to EMFX continued in August, and as such, the asset class returned 1.79%. The asset class also benefited from continued strong inflows. Russia was the top performer for the month as falling inflation reinforced expectations for additional monetary easing. The Philippines was the bottom performer as news of its widening current account deficit weighed on the currency.
New Issuance
EM sovereign issuance slowed in July, totalling just $3.14bn, The “summer slowdown” in EM sovereign debt issuance persisted in August. Looking ahead, while we anticipate a slight uptick into the end of the year compared to August lows, we expect the general slowdown in issuance witnessed thus far in the second half of the year to endure as supply tends be disproportionately larger in the first half. Net issuance remains manageable for both sovereigns and corporates.
Flows
Inflows continued across hard, local and blended currency funds. The $4.38bn of inflows in August (and $51.82bn year to date) have been supportive of the asset class and have helped to absorb the bulk of new supply.
Anisha Goodly is Emerging Markets Portfolio Specialist at TCW
