Payden & Rygel: 2025 Outlook for Emerging Market Debt

December 5, 2024

EM countries have been rewarded by rating agencies: two-thirds of EM credit rating actions in 2024 were upgrades, the most positive trend since the 2020 pandemic. EM corporates have managed their balance sheets well, with net leverage levels holding below US peers. China’s slowdown has not weighed heavily on other EM countries, and we see strong growth prospects in India, Indonesia, Saudi Arabia, Brazil, and other large countries, that are picking up the slack.

The challenge looking forward is related to policy uncertainty in the United States. For EMs, this uncertainty revolves around trade tariffs, prospects for the Fed’s easing cycle, and the effect of these variables on the path of the US dollar. Overall, we see balanced risks around these issues, and we envision that there will be a mix of winners and losers. The change in the US approach to global trade is not new. Due to a variety of factors – nearshoring, rising South-South trade, higher commodity prices – the negative effects of tariffs have been smoothed out. Ultimately, the pandemic and inflation shocks were much more disruptive, and those have faded.

Structural forces that will continue to benefit EM debt investors are: 1) stronger long-run growth prospects, and 2) the broadening out of the investment opportunity set. Today’s EM debt investors can select from sovereign, corporate or local market opportunities in about 90 different countries, across all geographies and sectors.

Say, for example, that US trade policy unfolds in a way that causes slower global growth. In response, investors can allocate to countries with lower trade openness, shift to more defensive corporate sectors, or take advantage of falling interest rates (while hedging out currency risks). A reacceleration of inflation would pose a greater challenge, but we imagine the incoming US administration is well aware of the political problems that come with rising prices. A slower Fed cutting cycle – which has been priced in as of late 2024 – is still a cycle suggestive of a soft landing.

One of the most important support factors for EM countries has been the credibility of their central banks. Following proactive hiking cycles in 2021-2023, EM central banks were able to start cutting rates in 2024, but they have taken a cautious approach, keeping policy rates well above inflation. Thus, as we enter 2025, EM central banks are in a good position to either stay on old, or ease gradually, with room to cut more aggressively if needed. This posture will help EM economies navigate choppier waters, should they emerge.

The US dollar may remain favored to start 2025, and investors will likely tread cautiously in EM currencies in the short-term. Ultimately, a stronger dollar promotes greater US imports – the very situation the incoming US administration is trying to avoid. Considering this, the current high valuation of the US dollar, and the prudent monetary policy being run by EM central banks, we think prospects for EM currencies are balanced to constructive in the medium term.

Finally, the EM debt outlook is supported by favorable valuations. JP Morgan’s main hard currency EM sovereign debt index yields nearly 8%, sitting at the 84^th percentile of the past 20 years. The asset class shows value compared to other fixed income sectors, like US credit. The EM corporate debt market has an investment-grade average credit quality, with credit spreads above developed-market peers, particularly when adjusted for leverage. At Payden, we believe there are excellent opportunities for investors to generate income and gain diversification across the EM debt landscape.

Kristin Ceva is a Managing Director at Payden & Rygel. Kristin is a member of the firm's Investment Policy Committee and is a Senior Portfolio Manager directing the firm's emerging market debt strategies. She also is a frequent speaker at industry forums and in the media, focusing on topics related to international investing and emerging markets.