LatAm has been underperforming YTD on the back of negative idiosyncratic factors (politics, Covid) and longer duration. Politics will continue to weigh in Q4, but the situation has improved with better vaccination rollout and economic recovery.
Fiscal consolidation is the main source of concerns. Several countries will reduce their fiscal deficit in 2021 but it should not be enough to alleviate medium-term concerns. Upcoming elections could jeopardise the fiscal tightening.
That said, some countries offer value now. We recommend Mexico EUR and Chile EUR. Mexico is benefiting from a tight fiscal stance and the downgrade risk has been fading substantially. Populist risk has been diminishing. Chile spreads are attractive compared to rating peers. Political risk is remote, and fundamentals are still solid. C olombia, after a significant widening, is attractive. Expected fiscal improvement will provide support. On the other hand, it is too early to take risk in Peru. The risk of disruptive economic and fiscal policy is still too high.
Focus on IG over HY
Within a more volatile environment, we turn OW EM IG over HY as we expect the IG/HY compression trade to lose steam. Indeed, EM IG outperformance will be driven by its low beta status while EM HY tends to underperform in a rising rate environment driven by higher real yields.
IG valuations are tight and so we focus on BBBs and low duration names. The recent sell-off provide opportunities in EM Europe that has been underperforming or in IG MENA where valuations have been cheap and could benefit from higher oil prices. We still avoid Asia IG where spreads and high duration do not offer a buffer against higher core rates.
In the HY space, the strong performance through the summer will be hard to replicate. Question marks on the global growth and the Chinese slowdown should hurt temporarily high beta names. Moreover, EM HY issuance pipeline will turn heavy while market is OW. We note that the more-than-usual difficulty to absorb the latest Nigeria and Egypt primary issuances. In terms of valuation, EM HY looks globally cheap, but it is driven by distressed names. Several HY names, especially B and below, still exhibit poor fiscal metrics and so we focus on the quality BBs. That said, the new SDR allocation is providing some support to low-income countries, especially in LatAm.