IMF 2023 Spring Takeaways: Tailwinds for EM Local Debt
May 19, 2023
Watch Time 4:10 MIN
Eric Fine, Portfolio Manager, Emerging Markets Fixed Income: Hi everyone, I'm here with my colleagues Dave Austerweil and Natalia Gurushina who just attended the spring IMF (International Monetary Fund) meetings and I'm going to ask them some of their takeaways. The reason we go to the IMF meetings—and we've been going for over 30 years—is we meet essentially every finance minister and central banker in the world. In addition, there's trillions of dollars of assets under management in a lot of these rooms, and we get important pulse-taking for the market.
So Dave, during the past month, the decline of the dollar's reserve status has led headlines. In our team, we've been noticing the growing use of EM currencies in trade for oil, for example. How are IMF participants reacting to the story of the decline of the dollar status and the rise of EMs?
David Austerweil, Deputy Portfolio Manager, Emerging Markets Fixed Income: The reversal of globalization and trade fragmentation were the big themes at IMF, but that much explicit talk about de-dollarization. Generally, there is skepticism that the U.S. dollar can be replaced because there isn't any other safe liquid bond market of comparable size. But that misses the point. Market prices react to changes in flows, and those changes only need to be marginally different than the status quo. It just takes China not reinvesting some of its trade surplus into U.S. Treasuries, instead moving a portion of that to Southeast Asian bonds, to make those currencies rally. If this is a slow secular shift, you can see those currencies outperform for years. EM local currency was chosen as the top performer for 2023 among EM investors for the first time in my memory. The level of foreign ownership in local markets is the lowest it has been over the corresponding time period. This is an extremely bullish setup for EM local debt.
Eric Fine: Natalia, what were the most positive economic stories that you gleaned from IMF meetings?
Natalia Gurushina, Chief Economist, Emerging Markets Fixed Income: I would say that whereas the U.S. and Europe face a recessionary or weak growth landscape, there is continued positivity for emerging markets. And this includes several aspects.
Okay, so one interesting story is declining neutral rates in emerging markets and rising neutral rates in developed markets. And this means that EM local currency bonds—and by the way, many emerging markets hiked interest rates far earlier and far more aggressively than developed markets—so basically it means that for EM local currency bonds, there will be a secular tailwind, including from lower inflation.
Eric Fine: Thank you. And Dave, kind of summing up, what did the meetings mean for our portfolio?
David Austerweil: So for our portfolio, this means we are allocated over 50% to EM local debt, especially in countries with strong external surpluses like Thailand, Brazil, and Indonesia. Indonesia is our largest overweight in the portfolio. These markets have exhibited amazing resilience lately with local Indonesian bonds actually being less volatile than U.S. treasuries. And for our U.S. dollar allocations, we favor high yield sovereign bonds that naturally have lower duration and much higher yields relative to U.S. Treasury yields. This gives them the ability to absorb some of the pain that comes from the rise in U.S. interest rates. The countries we own, like Angola and Mozambique, also benefit from higher commodity prices. The repricing of U.S. interest rates due to a hawkish Fed remains the major risk for markets. For this reason, we have very low exposure to the highest quality U.S. dollar EM sovereign borrowers that tend to have low spreads relative to U.S. Treasuries and much longer dated borrowings. Where we do have exposure to these credits is often to the shortest duration portion of the curves.
Eric Fine: Thank you everyone for listening.
Please visit VanEck.com for our written review of the recent IMF meetings. Dave Austerweil wrote a recent piece called, IMF Spring Meetings: A Season of Wishful Thinking. And like I said, you can find that on VanEck.com. Thank you.
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Source: IMF.
International Monetary Fund (IMF) is an international U.S.-based organization of 190 countries focused on international trade, financial stability, and economic growth.
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