Yahoo Finance DoubleLine Capital: Fed 'no landing' scenario positive for emerging market debt
DoubleLine international fixed income director Luz Padilla says as long as the Federal Reserve's interest rate hikes don't cause a recession, emerging market bonds can continue to perform well.
"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," Padilla told Yahoo Finance Live in an interview on Wednesday. "I think that could offset increases in yield because we may see [spreads] tightening on the other end."
The Fed has raised rates by 450 basis points, or 4.5%, since last March and expects to raise rates further, creating ripple effects for emerging market economies.
The Fed's rate hikes increase the cost of funding for emerging market countries and companies with dollar-denominated debt. Investors are increasingly betting on a "no landing" scenario in which the Fed continues raising rates into a resilient economy with inflation that remains sticker than previously thought.
"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," said Padilla.
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."
Emerging market debt had rallied to start 2023 on investor hopes the Fed would pause, or even reverse, its interest rate hikes. As investor hopes for this pivot have faded, EM debt has been under pressure.
Padilla favors Mexico and expects its credit rating to improve, noting companies are taking advantage of setting up factories in Mexico instead of China and that Mexico has natural resources and a good population.
While some investors are optimistic China could outperform as its economy reopens this year following COVID restrictions, Padilla isn't putting money to work there.
"We actually did the opposite. And the reason for that is mostly to do with Russia," Padilla said.
Padilla says China's investment-grade corporate bonds aren't paying much and warns that if China were to invade Taiwan that would hurt Chinese bonds the same way Russia’s bonds suffered after invading Ukraine.
"The after effects of the Russian invasion of Ukraine in our markets were shocking," said Padilla. "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."
Padilla still views the Russia-Ukraine war as a risk to investing in emerging market bonds as a whole, especially if there is an escalation in the war.
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