Luz Padilla, the international fixed income director of Doubleline Capital, says emerging market bonds will continue to perform well, so long as the Federal Reserve’s interest rate hikes do not trigger a recession.
In an interview with Yahoo Finance, Padilla said, “People are talking about a ‘no landing’ scenario, which means no recession, and if we don’t see a recession that means that all these countries, all these companies can continue to do well. I think that could offset increases in yield because we may see [spreads] tightening on the other end.”
Since last March, the Federal Reserve has hiked interest rates 4.5%, and as further rate hikes are expected, it is generating ripple effects for emerging markets.
As the Fed raises rates emerging market countries and companies with debt denominated in US dollars will see their funding costs increase. However investors are increasingly betting on what is being called the “no-landing” scenario, where the resilient economy and job market lead the Fed to continue raising rates, as inflation remains stickier than anticipated.
Padilla noted, “When you look at all these countries, all their potential with their natural resources their population, they have a lot to work with…this asset class came from basically almost being unrated to now 50% of our countries are investment grade-rated.”
She added: “Now we’re at a point where all-in yields for emerging market debt are around 8.5%, and I think 9% is an interesting level if people are thinking of getting in into an asset class that I think is an improving credit story.”
Following an upbeat beginning to the year, as investors hoped a pause, or even a reversal in Fed tightening might be on the horizon, emerging market debt has come under pressure lately as inflation has persisted and jobs data continues to show strong hiring and low unemployment.
Padillo says Mexico is looking positive, as its credit rating appears poised to improve, companies have begun setting up their factories in Mexico, rather than China, and it has the natural resources and industrious population needed to succeed.
Although some feel China is on the cusp of a resurgence, with its economy poised to fully reopen, Padilla hasn’t felt ready to begin investing there. She said, “We actually did the opposite. And the reason for that is mostly to do with Russia.,”
She warned China’s investment-grade corporate bonds are not yielding much, and should a conflict break out over Taiwan, Chinese bonds would suffer just as Russia’s bonds suffered following the invasion of Ukraine.
She added, “The after effects of the Russian invasion of Ukraine in our markets were shocking. Russia was almost immediately taken out of our index. They went from an investment grade story to a non-rated credit. For me to have that one thing out there, that could basically blow up your whole investment case. When you’re not really getting paid all that much I’d rather not participate at this point.”
Overall, she says the Russia-Ukraine war poses a major risk to investing in emerging market bonds, especially should the conflict escalate.
