Trump, IMF’s leniency strong tailwinds for emerging market debt

• The effect of Trump’s foreign policy on energy, commodity prices and the US dollar watched.
• See potential upside in Ukraine, Israel bonds if ceasefire achieved.
• EM hard-currency high yield sovereign bonds attractive.

Donald Trump’s election as US president and the International Monetary Fund’s (IMF) approach towards debt restructuring are the two factors that will shape the outlook for emerging market (EM) debt in the coming months.

Trump will be taking over at a time when global economic activity remains resilient and financial conditions have eased after many central banks commenced their rate cutting cycles. The IMF forecasts EM real economic growth to increase and fiscal deficits to improve in 2025 for most EM economies.

In my view, Trump’s foreign policy and its influence on geopolitics will have an important bearing on the fiscal and growth outlook of many emerging markets. The effect of his policies on energy and commodity prices, and the direction of the US dollar, will be closely watched.

Current Spreads* vs Tights during 2Q16-1Q18 (in bps)

In order to gain insights into the main factors that could be affecting sovereign debt, including EM countries, I attended more than 20 meetings with leading financial figures, policymakers, and experts at the IMF and World Bank meetings in October.

Tariff war, dollar

While the outcome of the US election wasn’t known at that point of time, Trump’s pledge to raise import tariffs repeatedly came up for discussions.

Many countries were gearing up for a global tariff war and the currencies of China and Mexico have weakened in anticipation. A stronger US dollar, rebound in inflation, higher rates and lower growth are some of the consequences official IMF economists see as a result of punitive tariffs. To guard against any inflationary resurgence in the US due to tariffs, we have increased our exposure to US inflation-linked bonds in our Global Sovereign Opportunities strategy.

However, proponents of Trump say that much of the heated rhetoric is simply negotiating tactics. Higher tariffs could potentially boost inflation and interest rates, making the US an attractive destination for capital inflows, further boosting the dollar.

Trump’s avowed preference for lower policy rates to help US manufacturing and exports could mean he may favour a weaker currency. The greenback has gained 7% against a basket of currencies since late September.

Ukraine, Israel

Two seemingly intractable issues that’ve vexed the world in recent times will be in focus immediately after Trump’s inauguration on Jan. 20.

At the moment, the US is supporting the war efforts of Ukraine and Israel. Trump has repeatedly said that he would be able to solve the Ukraine-Russia conflict in a day. While his claim may sound exaggerated, it underlines the priority he accords to brokering a negotiated settlement between the warring parties.

Expectations of normalcy in the Middle East have increased given Trump’s efforts to improve Arab-Israeli relations through the Abraham Accords in his first term. I believe there could be a potential upside to the restructured Ukraine dollar bonds and Israeli hard-currency and local-currency bonds if the warring parties agree to end fighting. In Lebanon, a ceasefire between Israel and Hezbollah has already taken hold.

It is worth noting that the IMF and World Bank meetings as well as the BRICS summit took place around the same time. The competing summits marked a growing economic and geopolitical divide between the ’global south’ and ‘global north’ and the ever-increasing fight for global influence.

This, combined with the ongoing conflicts, contributed to the sense that the IMF is taking a more lenient approach in enforcing its conditions on vulnerable countries to avoid alienating or pushing them into distress. The recent debt restructurings of Ukraine, Ghana and Zambia brought attention to EM sovereign liquidity issues.

IMF’s fresh approach

The IMF’s attitude towards Argentina was by far the most positive, as their bonds continue to rally. New International Financial Institution (IFI) funding and US dollar inflows are favourable factors although currency restrictions pose a challenge. We believe any easing of foreign exchange controls will be gradual, and the IMF is willing to be patient on the implementation of structural reforms as they recognise the political challenges the government faces ahead of the election next year.

Despite the IMF’s more relaxed attitude to enforcing conditions, some problem areas remain. The general view at the October meeting was that the Common Framework for debt treatments, which provides a mechanism for low-income countries to restructure their debt by bringing creditor countries together, hasn’t been effective.

Rising debt, deficit

Rising public debt and widening fiscal deficit are major concerns in developed and emerging markets alike as political discourse in many developed and emerging market countries favours higher spending. As matters stand, a host of countries are negotiating with the IMF. Discussions are underway for new deals for El Salvador and Angola. The IMF is likely to renegotiate a new programme with Senegal, after it revealed hidden debt that brought up its public debt to 84% of GDP. They are cautious on Kenya and Egypt but see progress in Zambia, Ghana, and Nigeria.

Overall, we find EM hard currency high yield sovereign bonds attractive given the IMF’s patience with the pace of reform adoption and expectations that Trump’s ascendancy will help in dissipating geopolitical risk. Within the high-yield space, we expect the CCC-rated segment to outperform as the spreads are about 335 basis points above the tights seen between the second quarter of 2016 and the first quarter of 2018.

Fund specific Risks

• Interest Rate Risk - The Strategy can invest in assets whose value is sensitive to changes in interest rates (for example bonds) meaning that the value of these investments may fluctuate significantly with movement in interest rates .e.g. the value of a bond tends to decrease when interest rates rise. 
• Credit Risk - The issuer of a bond or a similar investment within the Strategy may not pay income or repay capital to the Strategy when due.
• Derivative risk - the Strategy may use derivatives to generate returns and/or to reduce costs and the overall risk of the Strategy. Using derivatives can involve a higher level of risk. A small movement in the price of an underlying investment may result in a disproportionately large movement in the price of the derivative investment.
• Emerging Markets Risk - Emerging markets are potentially associated with higher levels of political risk and lower levels of legal protection relative to developed markets. These attributes may negatively impact asset prices.
• Share Class Hedging Risk - The share class hedging process can cause the value of investments to fall due to market movements, rebalancing considerations and, in extreme circumstances, default by the counterparty providing the hedging contract.
• Contingent convertible bonds - The Strategy may invest in contingent convertible bonds. These instruments may experience material losses based on certain trigger events. Specifically these triggers may result in a partial or total loss of value, or the investments may be converted into equity, both of which are likely to entail significant losses.
• Sub investment grade bonds - The Strategy may invest a significant portion of its assets in securities which are those rated below investment grade by a credit rating agency. They are considered to have a greater risk of loss of capital or failing to meet their income payment obligations than higher rated investment grade bonds.
• Pricing risk - Price movements in financial assets mean the value of assets can fall as well as rise, with this risk typically amplified in more volatile market conditions.
• Currency (FX) risk - The Strategy can be exposed to different currencies and movements in foreign exchange rates can cause the value of investments to fall as well as rise.
• Counterparty Default Risk - The risk of losses due to the default of a counterparty e.g. on a derivatives contract or a custodian that is safeguarding the Strategy's assets.
• Charges from capital - Some or all of the Strategy's charges are taken from capital. Should there not be sufficient capital growth in the Strategy this may cause capital erosion.

For a more detailed explanation of risk factors, please refer to the "Risk Factors" section of the Prospectus.

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