Heavy bond issuance from large US tech companies is widening US investment-grade credit spreads. In contrast, Emerging Market issuers have already completed most of their annual issuance, creating favorable supply dynamics. This has led to EM debt outperforming its developed market counterparts despite broader market headwinds.
The recent rise in 10-year US real yields has reached a two-sigma deviation, a statistical level that has historically preceded a reversal. This suggests that yields may be topping out, forming a quantitative basis for a more constructive view on emerging market assets which are highly sensitive to US rates.
While high-yielding frontier markets have been resilient to Fed hikes and a strong dollar, their strength is threatened by crowded investor positioning. A significant external risk-off event could trigger a rapid unwind, as investors are concentrated in the same few liquid markets, creating a key vulnerability.
With top-down global factors like Fed policy and geopolitics creating frustrating, sideways markets, the best opportunities lie in markets with unique, idiosyncratic stories. These countries, such as Colombia, should have lower correlation to the challenging external environment, offering a path to generate returns.
Beyond typical macro factors, the Super El Niño is a major risk for frontier markets that rely heavily on domestic food production. Adverse weather could spike food and headline inflation, potentially forcing central bank action and putting upward pressure on bond yields, leading to a more neutral stance on rates.