For Emerging Market Debt, A Sustainable Recovery

After several difficult years, improved fundamentals are yielding a sustainable recovery in emerging market local currency-denominated debt

After several difficult years, the outlook for emerging market debt (EMD) denominated in local currency has brightened considerably. From May 2013 to January 2016, local currency EMD dropped 33% in US dollar terms as the US Federal Reserve (Fed) tightened monetary policy, the US dollar strengthened and commodity prices fell. Since then, however, the tightening of US monetary policy has become well understood by the market, the rise of the US dollar has come to a halt, commodities have stabilized and economic conditions in many emerging-market nations have improved. These conditions, which have led to a strong recovery in emerging market local currency debt, are likely to continue. We expect this combination of supportive external drivers and improving domestic fundamentals to yield strong total returns for the asset class this year and likely into 2018.

The external drivers that account for much of the variability of total returns— global rates, the US dollar and commodity prices—are explained in further detail in our November 2016 white paper, "Understanding Risk and Return in EM Local Currency Debt." In the next few paragraphs we explain why these external drivers have turned more supportive of the asset class over the last year or so.

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