China’s reopening good for emerging markets debt

We see three key U-turns going into 2023: 1) China reopening, 2) the continued  raising of interest rates to fight inflation by the Federal Reserve (Fed) and 3) a looming US recession.

1) In China, markets spent 2022 digesting the property sector collapse and strategic divorce with the US, and are only slowly waking up to China reopening. This is very supportive of commodity prices, Asian EMFX and specific Chinese credits.

2) The US Federal Reserve (Fed) and inflation dominated the bond narrative in 2022, but this was capped by two roughly 100 basis points rallies in 10-year yields in the second half of the year, as the bond selloff became exhausted as part of an “everything” rally—with “everyone” now bullish bonds for the New Year. This is a setup for another selloff in bonds and a hit to risk-free duration and some spread duration.

3) Growth was not a key market driver in 2022, but despite continued growth momentum in the US, 2023 will end up being a discussion of how bad the US recession will be. This argues for caution and selectivity on spreads, spread duration and risk generally.

Overall, the above describes a bumpy world with few obvious thematic opportunities, other than emerging markets debt. Emerging markets debt stands out with asset prices that can benefit directly from China's reopening. It stands out with its higher-yield bonds that can generate a return in a potentially sideways or bumpy bond world. Many emerging markets stand out as beneficiaries of higher commodity prices, not victims of them. Emerging markets, for the most part, have independent central banks that hiked interest rates early and more than developed markets, making inflation less of a worry in emerging markets than in developed markets. For now, we continue to favour Asian currencies, China property and selective high-spread sovereigns, and are looking to reduce low-beta duration.