Trade War Threatens Best Emerging-Market Bond Gain in Decade

(Bloomberg) -- The best returns in a decade for emerging-market bonds just got a further boost as central banks move toward more easing. Now fund managers must navigate trade tensions and geopolitics that could derail the rally.

Investors are optimistic after the Federal Reserve signaled it was ready to cut interest rates and the European Central Bank indicated more stimulus may be on the way. But money managers are tempering their outlook with caution on the planned meeting between Donald Trump and Xi Jinping at the G-20 summit this week, and amid tensions in the Middle East.

“We are bracing ourselves” for the U.S.-China trade war to continue, said Angus Bell, a senior portfolio manager in emerging-market debt at Goldman Sachs Asset Management, who doesn’t see a resolution to the trade dispute in the near future. The money manager expects “mid-single digit returns” for the rest of the year in EM dollar bonds, he said.

Union Investment Privatfonds GmbH says there is the risk that somewhere a human factor will lead to an accident. Tensions between the U.S. and Iran have surged after the downing of a U.S. drone and attacks on tankers. Amid the trade uncertainties, Schroder Investment Management says that in Asia, most investment-grade issuers should be less affected given they aren’t directly exposed to global trade and will benefit from strong Chinese economic policy support.

Asia’s strong economic fundamentals also make Japan’s Asset Management One Co. prefer emerging-market credits from the region, which they expect will be more resilient in a risk-off scenario.

Even after emerging-market dollar bonds scored a 9% return from Dec. 31, the most for any similar period in a decade, many investors still see them continuing to do well, as monetary easing burnishes the appeal of the higher-yielding assets.

Read more: Easy Does It Across Global Central Banks in 2019’s Busiest Week

Here are further views from the investors and analysts:

Brett Diment, head of global emerging-markets debt at Aberdeen Standard Investments:

• “If we see a period of somewhat slower U.S. growth, the Fed cutting rates, but not a U.S. recession, that is generally a pretty good environment for emerging-market fixed income"
• Expects a de-escalation in frictions as the 2020 U.S. presidential election nears and Trump focuses on re-election

Angus Hui, head of Asian credit and emerging-market credit at Schroder Investment Management:

• In an environment of lower rates for longer, carry remains important, and Asia investment-grade debt continues to be one of the relatively higher-yielding markets in the IG world
• Most high-yield credits in China aren’t directly exposed to global trades and the recent correction offers some interesting entry points, such as in short-dated Chinese property credits

Satoru Matsumoto, Tokyo-based fund manager at Asset Management One:

• Expects local currency IG EM bonds to outperform in second half with large risks surrounding Trump administration and trade disputes

Cathy Hepworth, co-head of the emerging-markets debt team at PGIM Fixed Income:

• Some bonds of sovereigns that have bailout packages from the International Monetary Fund pay 7% or more, and are attractive where central banks are stepping in to prop up growth

Sergey Dergachev, senior portfolio manager at Union Investment Privatfonds GmbH in Frankfurt:

• Indian and Indonesian corporates offer good relative value and election risk is out of the way in both countries
• Cautious on Mexican and Chinese credit due to headline risk and long-term risk of stress in ties with U.S.
• Key risks are fears that with so many geopolitical events happening, there could be an “an accident,” for example, in Iran situation

William Goh, fixed-income analyst at Lion Global Investors:

• China’s hardware technology sector has been caught in the cross-hairs of the U.S.-China trade tensions, so prudent to pare back our exposure to the sector
• Have been incrementally moving into defensive positions, as trade tensions between the U.S. and China continue; core China state-owned enterprises remain a relative safe haven, welcomed by Chinese onshore investors and some Asian investors

Raphael Marechal, head portfolio manager, emerging markets at Nikko Asset Management:

• “The search for yield is going to be even greater in the second half of the year”
• “We expect risk appetite to remain excellent for the last six months of the year, so that’s more of a positive for high-yielding assets”

Bryan Carter, head of emerging-market fixed income at BNP Paribas Asset Management:

• Anticipates another 3-5% in returns in the second half for EM dollar bonds, with Fed easing an important tailwind

--With assistance from Lilian Karunungan.

To contact the reporters on this story: Finbarr Flynn in Tokyo at fflynn3@bloomberg.net;Kyungji Cho in Seoul at kcho54@bloomberg.net;Yumi Teso in Bangkok at yteso1@bloomberg.net

To contact the editors responsible for this story: Andrew Monahan at amonahan@bloomberg.net, ;Tomoko Yamazaki at tyamazaki@bloomberg.net, Beth Thomas

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