After external risks to EM remained elevated at the beginning of 2018,we believe that, in the medium term, the risks around US monetary policy normalization and fiscal expansion have so far been offset by the synchronized global growth recovery, the solid performance of commodities, and investor appetite for risky assets. The case for EMD remains supported by the accelerating EM growth, limited China risks and improving fundamentals. Asset class valuations are still extended on an absolute basis but remain attractive versus US credit. Asset class flows printed a record high in 2017 but after a disappointing 2013-15 period. We expect these solid asset class inflows to persist in 2018.
However, we retain an overweight in Hard Currency Debt, and are constructive on commodity exporters like Angola, Ecuador, Kazakhstan and Nigeria, and on specific idiosyncratic re-rating stories like Argentina, Ukraine and Egypt.
Our underweights include US treasury-sensitive credits with tight valuations such as Panama, Peru, Chile, China, Uruguay and the Philippines.
The disinflation theme has run its course in most lower-yielding emerging markets, as less negative output gaps and the rebound in energy prices should put upward pressure on prices. However, the high real rate differential to the US should continue to play in favour of local duration in higher yielders with subdued inflation and scope for central bank easing.
We continue to see value in EM Local Rates and remain overweight select high-yielders that are supported by high real rates and constructive disinflation dynamics (Brazil, Russia), and South Africa, which is benefiting from positive election results and a slower expected inflation. We are underweight lower-yielding local rates markets in Asia (Thailand and Malaysia) and CEE (Poland, Hungary and Romania).