External risks to EM have declined consistently since the beginning of the year as DM political uncertainty subsided with the European elections producing market-friendly outcomes and US policies so far avoiding focussing on extreme trade protectionism. The US Fed hiked the policy rate in March but maintained a dovish stance. EM growth has also surprised relative to expectations and is adding to a synchronized global growth recovery which is supportive of EM fundamentals overall. We retain an OW in external debt as we are constructive on commodities and specific idiosyncratic re-rating stories like Argentina, Ukraine, Egypt, and Ghana.
Our underweights (UW) include US treasury-sensitive credits with tight valuations such as Panama, Peru, Chile, Uruguay, Philippines, and Poland. We also hold an UW in South Africa, which suffers from tight valuations, domestic political transition, downgrade risks, insufficient fiscal adjustment and weak growth.
Local rates will continue benefitting from EM disinflation and accommodative EM central bank policies although the easing cycles might be shallower than expected given Fed monetary policy normalization. The EM cyclical growth recovery is also expected to continue as most EMs remain at below-potential growth. We continue to see value in EM local rates and remain OW select high-yielders (Brazil, Colombia, Indonesia). We also hold and overweight to mid beta countries like South Africa (soft growth and disinflation) and Mexico (underperformance has priced-in political risks).
On the other hand, we are UW treasury-sensitive Asian low yielding local rates markets such as Malaysia. We also have an UW in Argentina (although a high yielder) on high and persistent inflation and tight valuations and despite a hawkish central bank policy. We also maintain our underweight in Hungarian rates on the back of expected reflation in 2017.