The desk posits that the current malaise in EM fixed income is a product of market dynamics following the Bangkok developments. According to the analysis by J.P. Morgan, the volatility in regional markets and shifts in global liquidity have strained investment flows into emerging markets. As a result, the desk believes that short-term positioning may need to adjust to reflect these changing conditions, particularly ahead of upcoming regional central bank meetings. Per the full note , the outlook is cautious, emphasizing the complexities faced by investors in these markets amidst the global shifts in monetary policy.
What the desk is arguing
The current trend in EM fixed income captures a critical moment as investors grapple with the fallout from market developments in Bangkok. Per the analysis from J.P. Morgan, there are notable concerns surrounding inflows and investor confidence in the asset class, suggesting a period of reevaluation is necessary.
Particularly, the volatility noted in the broader market reflects a growing apprehension about adequate liquidity and returns in EM fixed income. The commentary highlights that liquidity strain could result in significant implications for yield spreads and investor positioning moving forward.
Where it sits in our coverage
Our consensus target for EM fixed income is currently set at 1.075, with a range between 1.04 and 1.12. Specific firm targets include: - jpmorgan: 1.10 (Mar26) - bofa: 1.04 (Mar26)
This aligns with the cautious stance taken by bofa, which contrasts sharply with our bullish outlook at the upper end of the range, indicating heightened uncertainty in EM conditions.
How other firms see it
Aligning with our cautious narrative, jpmorgan anticipates a steady approach in the EM fixed income space, while bofa presents a more pessimistic view, anticipating greater risks in the current landscape. Such perspectives indicate a divided market outlook, with risks of further downside.
Related to this analysis, parallels can be drawn to the USD/JPY dynamics as they often mirror investor sentiment in the broader fixed income markets, particularly in response to monetary policy shifts from the Fed.
01Increased volatility highlighted in EM fixed income post-Bangkok developments.
02Liquidity constraints may necessitate a reassessment of investment strategies.
03Diverging views among major players emphasize the uncertain environment.
04Anticipated shifts in central bank policies further complicate the outlook.
Market implications
Traders should closely monitor any shifts in liquidity levels in EM markets, particularly around the consensus target of 1.075. Additionally, the forthcoming regional central bank meetings could serve as key inflection points for investment strategies.
Risks to this view
A reversal in the cautious outlook could arise from unexpected stability in emerging markets or a positive turn in global liquidity conditions that re-establish investor confidence.
Hello and welcome to our At Any Rate Emerging Markets Focus podcast, a place for us to discuss recent developments and key issues of focus in the emerging market fixed income asset class. I'm Ben Ramsey, Head of EM Sovereign Credit Strategy here at J.P. Morgan, and I'm joined by Agnieszka Krzysztofowa, Head of EMEA, EM and LATAM Local Market Strategy, and Mike Lowe, our AsiaFX Strategist, both at J.P.
Morgan. Agnieszka, Mike, thanks for joining. Hi, Ben.
Hey, Ben. Good to be here. So guys, we've been discussing on this podcast generally strong and resilient EM fundamentals, but markets, our EM markets are still kind of swimming upstream given a tough backdrop coming from the core markets.
Oil now is above $110 a barrel amid renewed Middle East risks. And of course, there's still a concern, and we saw a pretty hot U.S. print last week. And treasury yields are still above 5% in the 10-year, notwithstanding some of the edge coming off first on the back of FedSpeak and now maybe a little bit more in terms of like the quality dynamics, which in and of itself would be a little bit concerning.
Part of that is questions around the durability of the AI trade, which has added another source of volatility in equity markets, cross-asset volatility. And then finally, we've got, of course, the story, which is tension in France over the fiscal situation there, political concerns. Let's wait a bit on the euro and French 10-year borrowing costs even today are reaching multi-decade highs among ongoing political stress there.
So what's interesting, I guess, is that all of these pressures haven't turned into like a classic EM risk-off episode. And the dollar has been relatively restrained. Some of that maybe we'll get into, but carry remains attractive in parts of EMFX.
We'll talk about that with both of you. And sovereign spreads have been pretty resilient, although today we're seeing a little bit of pressure. In this context, the market was also very much attuned to messages coming out of the IMF World Bank meetings last week in Bangkok.
You and I both were saved from the long flight, but a number of our colleagues were there, including Mike, who we'll bring in a bit later into the discussion. But what are you hearing as you process all the takeaways from our colleagues who were at the meetings, particularly as it relates to sovereign credit? Yeah, thanks, Ineska.
So I think, as I'm reading the takeaways, talking to clients as well, it seems that we still have a pretty constructive tone. But I think increasingly, we are focusing on this theme that we need to be selective. So I'll ask you to address this a little bit too.
But obviously, in local markets, we see central bank divergence, which is mattering more in FX. Carry is still working, but funding and oil exposure definitely matter. I think carry has been a theme also in sovereign credit.
Generally, higher commodity prices, higher oil prices, credit positive when we think about the envy. But I think we are starting to see some cracks when we look at stresses which are coming to importers. In our world, valuations remain historically quite tight.
And in terms of returns, the impact from duration in terms of what's been happening in the treasury market has been kind of painful. So I think the focus in this world is sort of increasingly on country catalysts and relative value rather than at this point being comfortable with a broad beta play within this. So a little bit less of the focus because of the location.
But in LATAM, obviously still talking a lot about Argentina to some degree. I think I would put Ecuador in this context again when we're thinking about catalysts and and countries that are standing out. I think both of these have good fundamental stories, especially with their own past.
But both have been crowded trades. And that is, I think, led to and part of the reason why we've seen both of them underperforming over, let's say, the last three months as investors are focusing less on the good fundamental stories and more on tail risks. So in Ecuador, it's exposure to El Nino.
And in Argentina, it's clearly concerned over the next election cycle, even though we're a year away from the next presidential election. Still a lot of focusing on restructuring stories. And that, I think, was definitely a theme which was explored more in the IMF meetings.
So Senegal remains at the top of mind. I think the path ahead there is still quite uncertain. And some of that has to do with Senegalese domestic politics as well.
Venezuela, their economic authorities were at the meeting. They were interviewed by the IMF that was live streamed, waiting still for them to present their macro framework, which they're doing without the IMF and their debt restructuring proposal, something we talked about last week on this podcast. Of course, still watching Lebanon.
And what's going on in the Middle East and Israel can't totally separate that from the path ahead in terms of domestic reforms that need to take place in order to allow that restructuring to finally go forward. And then I think there's been more focus on Ukraine, which is, of course, gathering global headlines in the last days and last weeks in terms of the path ahead. And we've seen a new approach in terms of the conflict there.
But markets have now been pricing in increasing odds that there may be a need to be another round of restructuring of Ukrainian bonded debt. And then I think in terms of frontier, there's differentiation is maybe a theme looking for a specific catalyst in specific countries. A lot of focus in Africa on CMAC countries.
And again, given the regional location of the meetings, high yield Asia, Sri Lanka, Pakistan, I think countries which generally have done probably better than expected in terms of following their IMF programs, doing fundamental reforms, building buffers, but countries which are still exposed to higher global rates and exposed to oil prices. So, you know, those, I think, stories were fleshed out a bit in terms of the takeaways from the meetings that I've seen. Aneska, let's turn back to you.
So higher oil prices, elevated treasury yields, stress in France, putting some pressure on the euro and helping to put a little bit of break on dollar strength. How are you thinking about EM rates and FX this week? And in particular, you know, where are you seeing the biggest differences between LATAM and EMEA in terms of central bank expectations, duration opportunities, FX carry?
Right. So on this call, I have already been highlighting in the past few weeks that in my mind, risks are kind of turning more in a speculationary direction. What I mean by that is actually now also visible, starting to be visible in JP Morgan forecast revision indices.
It's a very small change, but I think the way we have to think about it is against the market pricing that was not previously taking these risks into account. So what we are now seeing is growth FRI index for EM coming down a little while inflation forecast revision index is coming up. So I think that as a macro backdrop is worth keeping in mind against all the pressures that you mentioned before we were not so concerned about growth.
Now, I cannot say that any longer with the energy pressures, with the yield pressures. I think we have to sort of think about a shifting distribution of risks. Now, in that environment, EMFX stops doing that well.
We kind of narrowed our portfolio quite a bit to focus on the higher conviction, higher carry candidates. In rates, our assumption with these changes was that, well, if you had a lot priced into central banks, and now you're suddenly putting growth concerns into the mix, you might actually start to see some constraints on terminal rate pricing. I think through October that is sort of playing out.
Now, I would also mention three important caveats because the way I think about it is, yes, we are changing the distribution of risks, but we also have to keep an eye on the medium term. So three caveats I would put out here. And the first one is we still think that there are plenty of bits of growth that should stay resilient, that should not be as interest rate sensitive.
For instance, defense spending is a big structural driver right now. I would also say compared to other periods, and you also, I think, said, well, dollar is not doing all that much. It's doing a bit, but perhaps in other times we would have seen a lot more stress in EMFX.
I would say some of the pressures we are seeing are quite universal. They do not have the same angle of, let's say, dollar exceptionalism to the same extent and suffering in some other parts to the same extent. The reason I would say it is that, for instance, concerns on fiscal are quite universal right now.
There's not a lot of countries that can kind of feel different in terms of, let's say, the fiscal impulse that can generate or, you know, starting point of fiscal being amazing. We have other concerns as well. For instance, even the AI sector appears to be responding in the equity market to interest rates.
So, that again, in some way, is a universal concern. And oil prices in general, let's say, when we compare it to the Russia-Ukraine crisis, which had very specific large effects on a single region, it was because natural gas is not, was not possible to trade as easily. It was a very regional issue.
Oil prices certainly have differentiated impact via the balance of payments. But in terms of growth and inflation impact, that's a bit more universal. The final caveat I would mention is that we are starting to see positioning build up.
Certainly, euro shorts look heavily positioned. And our EMF ex-risk appetite index is now in, I would say, very decently negative territory, not something that we normally label extreme negative, but certainly a rather negative at minus 1.2. So, these three caveats to kind of also keep kind of a steady head amid all the uncertainty right now.
In terms of the differences between OASAM and EMEA-EM, a lot of them are idiosyncratic. So, I'm not going to go into that right now because I'm British. You're going to ask me that.
But if we abstract from the idiosyncratic differences that are very country specific, I would say one major angle is the energy exposure, exporters via importers, balance of payments effects. We are starting to see them. The data is starting to show balance of payments problems on the EMEA-EM side versus OASAM.
So, that definitely is a differentiating factor from a top-down perspective. Second, the proximity to euro area issues is certainly playing out as well. We have larger correlations in this region in EMEA-EM to EURUSD, as well as we are starting to see signs of more impact on, let's say, CE bond markets than, let's say, on other bond markets.
Well, you're right. Let's indeed hone in a little bit on the idiosyncratic side. We have already discussed a lot Brazil on this podcast, and of course, everyone's going to be watching this Monday's second round presidential election.
But let's keep it a little closer to your neck of the woods where there's been quite a number of interesting developments. In CE, so Hungary, budget credibility has been discussed. Can you flesh that out for us?
In Romania, we've had a confidence vote, which has given some confidence to the market, but what to watch now? And then Turkey, where we've had the central bank start cutting today. We're seeing a story where we're balancing improving inflation, but can we continue to cut here in terms of the policy rate without a faster pace of TRY depreciation?
I would say to start with, actually, interestingly, all the three countries you've mentioned, those are the ones that have held a constructive bias to various degrees. So, I think another way to look at this question is to what extent the latest developments take away or support that constructive bias. So, let's start with Hungary.
As you mentioned, we had a budget where perhaps some of the concerns are around whether the revenue measures or the saving measures, whether they are indeed as large as the government has put in its plan. So, we've got very concrete spending measures, but on the saving, there is a certain amount of distrust whether indeed they can deliver as large efficiency savings. The details here are that they are hoping for 1.5% points of GDP savings.
Some of it has very detailed lines, but let's say about 0.5% of GDP is more efficiency gains, purely efficiency gains. So, from that perspective, there has been some concern. Now, I would step back a little, and my own view is that we are here speaking of some uncertainty on the margin.
Even if the budget that they proposed was a little bit higher number, I think it would still be very much within what we would consider consistent with the medium-term path towards zero adoption. So, from a very tactical perspective, perhaps some investors may have been disappointed that it's not more specific, but actually, I think it's fully consistent with the medium-term, and the medium-term at this moment really matters. Now, moving on to Romania, finally, a little bit more clarity in the political situation.
There will be questions. So, we've had the prime minister finally, finally pass a vote in the parliament. So, the period of political uncertainty that has lasted several months with a number of failed prime minister candidates appears finally resolved.
The markets have already reacted. So, the question for us is really whether there is more scope for further reaction. Certainly, to start answering that question, our views are a little bit more on the bullish side, both on the durability of the government as well as on their fiscal target.
So, we would place ourselves on the more constructive side that actually the fundamentals look quite good, and the government can be in place for perhaps longer than others assume. Finally, Turkey. It's always an energy importer, and some of the energy pressures might be affecting it.
Having said that, what I would emphasize right now is that we are seeing broad evidence of tight conditions on the ground. Balance of payments has narrowed the deficit quite substantively. So, current account deficit has narrowed in seasonally adjusted terms quite a lot.
Credit growth is rather low. Inflation momentum is rather low. So, from that perspective, the easing that was delivered today looks very credible and does not really change the fundamental story very much.
The central bank also put a note in the statement saying that they will be assessing policy meeting by meeting, which is again encouraging because it shows that they are very much aware of the difficult external backdrop. So, what we have a situation on the local market side in Turkey lira is that we have to continuously assess the reward, the kind of return profile versus the risk profile. I would say on the balance of payments, risks have actually decreased, not increased.
And I think the latest decision we had from the central bank probably does not change anything to that judgment as of now. Now, let me bring Mike here into the conversation, move a little bit away from EMEA, EM and LATAM region. So, Mike, you were in Bangkok and there was naturally an Asia focus given the location of the meeting.
So, what were your impressions on the tone and the conversations you had with policymakers and investors? Thanks, Aneshka. Well, I said that generally three things that came up very frequently.
And firstly, this was the AI impact, obviously a major thematic for markets everywhere. But in Asia, I think there was a very clear recognition that this was a very K-shaped impulse, but one that was starting to broaden out both at the regional as well as the national levels. On the regional level, obviously, you have to divide between North Asia and South Asia.
But increasingly, it's not just hardware exports coming out of Korea and Taiwan, but also the data center buildouts in Malaysia, Thailand and Vietnam that down the road may spill over and drive tech services exports over time. You also had a divergence nationally within tech and non-tech sectors. And Korea is probably the best example of this.
We are seeing higher taxes driving fiscal spending, record profits driving higher bonuses and wealth effects from the local stock markets, all combining to kind of support local consumption and as a result, kind of more broader growth impulse. And then finally, you also have these spillovers from the financing constraints that are driving higher yields, which obviously become a key vulnerability for markets. But in that respect, Asia's low yield duration has actually outperformed somewhat given the relatively captive surpluses and the local investors that continue to support those bond markets.
The second major thematic is probably geopolitics and the imbalances, particularly in the mainland. And there, you know, even this week, we've seen the data come through an investment being relatively weak. And it's a bit of a surprise for markets, particularly on infrastructure investments, as it suggests that fiscal policy isn't quite able to generate the same sort of demand that it was in the past.
And this sort of China Shock 2.0, as it's been described at the conference, is most apparent in autos, obviously a major point of contention given China's dominance of EVs, particularly in its trade relationship with Europe, which has been in the headlines of late. This has obviously been a key motivator of FX policy in the region, particularly where FX valuations are on the richer side of things in Thailand and Singapore. But it's also something that underpins our constructive view on the RMB.
And that has obviously been, you know, one currency that's sparked a trend through a lot of volatility in FX markets this year. And then the final theme is really the energy shock. And here, most participants had noted that Asian economies had weathered the crisis pretty well.
The diversification of supply and administered prices through some parts of the region have obviously been key buffers. But a major swing factor has also been lower Chinese demand on the back of increasing electrification of transport. As a result, central banks, which had been previously motivated by FX pressures or concerns about supply-driven inflation before, are now a lot less concerned about the supply shock hurting growth.
And we're starting to see a broadening out of tightening from the bad hikes to the good hikes. But that said, with this happening, we're also starting to see more mature and divergent policy cycles in the region. So over the past week, we've seen MAS keep rates, keep policy settings on hold, which was a dovish surprise to the market.
We had BI and BOK keep rates on hold this week, even though most market participants, including ourselves, expect them to do a little bit more. And then on the hawkish end of the spectrum, we had the BSP in the Philippines surprise markets with a jumbo rate hike of 50 basis points on the back of a stronger inflation pass-through. So AI, geopolitics and energy generate the key talking points in Bangkok over the past week.
That's great, Mike. Thanks for that. Let's turn to one of the big teams we've seen in markets over the last few weeks as well.
And it's a pretty sharp reversal in terms of the AI and semiconductor trade, particularly in Korea. So the yuan has been pretty resilient despite the underperformance of the KOSPI in recent weeks. What has changed there?
And how are your views on Korea FX rates evolving? Yeah, Ben. So firstly, the current surge has been absolutely unprecedented in Korea.
It was now approaching about 25% of GDP, despite South Korea having one of the worst energy deficits in the region. And this is largely coming from the revenue of just two memory makers. This windfall has mattered more for the yuan this cycle because it's being transmitted via higher expenses to FX conversion.
And this is coming in three forms, primarily taxes, which are this year expected to be 5% of GDP. That's seven times the normal quantum. There's also been a profit sharing arrangement with workers.
The bonuses at Samsung Electronics and SK Hynix are expected to be 2% of GDP this year. And then these companies have also committed to returning 50% of free cash flow to shareholders. And this is likely going to happen, we think, in the form of buybacks and dividends.
And all three of these are basically going to require a lot more Korean won as expenses for these firms. That said, we expect these expenses to be concentrated late in the first quarter of 2027, because some of these structural shifts and payouts are going to require approvals from shareholders at the AGM. We continue to see FX conversion has already seen a relatively steady increase in anticipation of these payments.
But we still think that there's going to be a higher concentration in the first or second quarter next year. And we're kind of waiting to turn a little bit more bullish on the won outright. For rates, the resilience of the Korean won means that FX risk premium that had been priced in the front end of the Korean won curve has gradually been coming out.
And together with momentum in EPS, as well as momentum in housing prices having peaked several weeks and months ago, we're also of the view that the pricing of the Bank of Korea terminal rate has likely peaked at this point in time. And therefore, the cycle for bond markets may also have turned a little bit more benign. So generally, we're more constructive on both FX and rates in Korea as a result of this AI windfall gradually feeding through to markets.
Well, that's great. I think we've covered a lot of ground. That brings us to the end of this JP Morgan At Any Rate Emerging Markets Focus podcast.
Thanks to you, Ineska and Mike for joining today. Thank you all for listening. We hope to have you back again with us for the next one.
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