Despite record-high economic activity surprises, emerging market currencies (EMFX) are fairly valued, not overextended. This suggests near-term upside for spot prices is limited, making carry returns the more likely driver of performance in this bullish cyclical environment.
In a multi-year bullish environment for emerging markets, technical indicators that worked well post-2010 may consistently flash 'overbought' signals without leading to significant corrections. Strategists should attach a higher probability to these indicators failing, favoring the long-term structural view over short-term tactical signals.
A weaker dollar provides more than just a diversification benefit for dollar-denominated EM bonds. It fundamentally improves sovereign balance sheets by boosting commodity-driven fiscal receipts, reducing capital flight, enabling easier monetary policy, and ultimately aiding growth and debt dynamics, justifying tighter credit spreads.
Despite ten consecutive months of inflows, the current investment trend into emerging market bond funds is considered to be in its very early stages. Citing the massive, multi-year inflow period post-GFC (2009-2013) as a historical parallel, strategists believe the current cycle has significant room to run.
Emerging market high-yield bonds are demonstrating significant strength, with spreads tightening year-to-date while US high-yield spreads remain flat. This outperformance has persisted through record sovereign issuance, suggesting a strong underlying bid for EM risk and a successful spread compression theme within the asset class.