More EM countries expected to be under pressure

With a second quarter of emerging markets (EM) debt rebounding and many EM countries continuing re-opening, as they cannot afford to remain on lockdown, there will be a number of additional countries added to the list of the traditional ‘trouble spots’, according to Eaton Vance Management. 

It said countries such as Lebanon, Argentina, Zambia, Ecuador and Sri Lanka would continue to remain under pressure. 

Despite the COVID-19 pandemic, the second quarter represented a dramatic rebound for financial markets, including EMs, investor sentiment was buoyed by the massive policy responses around the world and the perception that a lot of the bad news was already reflected in lower asset prices, resulting in broadly compelling valuations, the firm said. 

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According to the emerging markets debt team at Eaton Vance Management, the positive tone was further reinforced by high investor cash levels and the easing of lockdown measures, which convinced many investors that peak uncertainty was likely past and that forthcoming economic surprises were likely to be to the upside. 

“We entered the quarter cautious, turned bullish mid-quarter, and are now more neutral overall. Pockets of opportunity still remain in the EM sector, but professional due diligence and selectivity remain more important than ever for taking advantage of them,” the firm said in a report. 

“As the financial shocks from COVID-19 and oil settle in, focus has turned to individual country fundamentals. While the rally in Q2 was broad, differentiation among countries was evident, based on varying policy responses and resulting economic outcomes, and the reverberations will continue over the rest of the year throughout the world.” 

The three main EM debt indices experienced significant gains during the quarter, with FX, local rates, sovereign credit spreads and corporate credit spreads all rallying: 

  • Local-currency sovereign debt, as measured by the JP Morgan Government Bond Index – Emerging Markets (GBI-EM), gained 9.8%, largely as a result of strong FX and interest-rate performance. 
  • External sovereign (dollar-denominated) debt, as measured by the JP Morgan Emerging Markets Bond Index – Global Diversified (EMBI), advanced 12.3%, thanks to significant compression of sovereign spreads over US Treasurys. 
  • EM corporate debt index gained 11.15%, as measured by the JP Morgan Corporate Emerging Market Bond Index (CEMBI), on the strength of big gains from both corporate and sovereign spread compression. 

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