Key takeaways:
- US dollar (USD) moves are generally considered to have a significant impact on EMs, but we believe not only has the direct impact on the Emerging Markets Debt Hard Currency (EMD HC) asset class declined in recent decades, but the impact is generally misunderstood.
- Emerging markets (EMs) have become less vulnerable to USD fluctuations due to increased local currency debt issuance, larger foreign exchange reserves, more credible economic policies, and shifted trade linkages, particularly towards China.
- While a stronger dollar generally coincides with wider credit spreads, what really matters for EMD HC is the underlying drivers of the US dollar moves. In particular, understanding the balance between the EM-US growth differential and financial conditions is likely to give a better guide.
EMD HC in a nutshell
EMD HC debt is an asset class denominated mostly in US dollars (USD), although some euro-denominated bonds are included in the universe, albeit outside typical benchmarks. Around half are investment-grade issuers, and the universe is also evenly split between net commodity importing and exporting countries.
There are more than 80 countries spread across the economic development spectrum, providing ample diversification in terms of credit risk. This translates into a fundamental resilience at the asset class level, as most global shocks are positive for some countries while negative for others. The fundamental diversification in terms of credit risk is consequently very high, providing an anchor for credit risk over the medium term.
Most of the somewhat more fragile high yield (HY) countries are in IMF programmes, with funding being conditional on programme execution, providing a strong policy anchor for the coming years. Default losses are expected to be close to zero after a round of EM restructurings completed in recent years after the pandemic.