EM Daily:EM Rates in 2017,Up and Down

We have published our 2017 outlook report on EM rates. 2016 was the year of high yielders. The hunt for yield that ensued from both local and foreign investors resulted in compressed term premium across high yielders and considerable inflows into the EM. Despite the ongoing re-pricing of risk that followed the US election, we expect positive performance for EM fixed income in 2017. With a considerable amount of premium already squeezed from the high yielders, we expect 6-8% return (net of FX) for EM - mildly lower than the 8.5% of return in 2016.

    We expect high yielders to once again be the focus, supported by falling inflation and central bank support. FX risk might weigh on inflation expectations and the implied timing of the cuts but we expect monetary policy to remain accommodative. Our favorite receivers are in Brazil and Russia. We also favor front end receivers in Turkey, Korea, Colombia and Chile, and further down towards the belly in Poland, Israel, South Africa, and China. We believe that term premium is low across EM, and with the exception of PLN and HUF, it has not been restored even after the outcome of the US election. Therefore we keep a steepening bias in high yielders and throughout low yielders in Asia. In contrast, Poland, Hungary, Israel and Chile have been ahead in the re-pricing of risk and could flatten in 2017.

    In terms of portfolio allocation, overweight Russia and Brazil, modestly overweight South Africa, Turkey, the Andeans and India. We underweight Korea, Singapore, Mexico, Czech and Israel. We favor linkers over nominals in Chile, Mexico, Israel and Turkey. In RV space we favor BRL local debt hedged over external and external debt vs. local hedged elsewhere.

    Foreign positioning has lightened up especially in high yielders like TRY and BRL. However, we see policy uncertainty as a greater obstacle to performance. In particular, we see higher US yields/stronger USD and issuance risk stemming from expansionary fiscal policies as the main risk factors for EM rates