Outlook 2015: Emerging markets prices to climb at first; headwinds persist; Turkey will outperform

By Christine Van Dusen

Atlanta, Jan. 2 – Emerging markets bond prices are set to rise in 2015 as monetary policy tightens in the United States, commodity prices continue to decline and the conflict in Ukraine remains unresolved, keeping yields lower for at least the first quarter.

“Moving into 2015, we see downside risks to energy prices on the back of OPEC’s decision to allow the market to ‘stabilize itself,’” said Candace Browning, head of BofA Merrill Lynch Global Research. “This could result in lower oil prices but also higher price volatility.”

The bank is forecasting that Brent crude oil prices will move to an average of $77 per barrel in 2015.

“The combination of a strong U.S. dollar, higher interest rates and relatively subdued growth should keep other commodity prices in check in 2015,” she said.

After the first quarter of the new year, oil prices could stabilize and the market will likely not react strongly to any further capital injections from the European Central Bank.

“Although we expect some mild growth of yields in [EM] next year, increases in bond yields should be moderate, as low inflation and ample global liquidity should help demand for issuance, which could continue to work against more pronounced yield increases,” according to a report form Erste Group Research.

Emerging markets credit, overall, should remain of interest to investors for at least the first half of 2015, but higher rates in the second half of the year could cause spreads to widen, a London-based trader said.

Market experts suggest that investors keep an eye on emerging countries that are making structural reforms.

“We prefer countries implementing reforms to open up their economies,” according to a report from BlackRock Capital. “A little reform can go a long way in boosting asset values. We like hard-currency EM debt due to relatively high yields.”

Economic growth predicted

Peering at the big picture for 2015, economic growth for emerging markets is expected to rise slightly to 4½% for 2015, driven by stronger U.S. growth, lower energy prices and “cyclical rebounds in a few large economies like Brazil and India,” Browning said.

But EM still faces some significant headwinds, said Jim McCormick of Barclays.

There will be weak growth outside of the United States, with China dragging down much of EM. Lower oil prices will weigh on exporters and oil-dependent economies, particularly those in Latin America. And higher U.S. yields and volumes are expected to hurt EM inflows. Additionally, a stronger U.S. dollar could hurt local bond returns, especially in Central and emerging Europe, the Middle East and Africa.

EM credit is “unlikely to repeat the returns seen in 2014,” and higher U.S. rates are “a big risk,” McCormick said.

Local debt is expected to post higher yields than that from developed markets, but currency depreciation versus the dollar will reduce returns, he said.

Dollar bonds strengthen

Dollar-denominated debt was one of the strongest asset classes in fixed income in 2014, according to a report from T. Rowe Price Group. But returns were mixed.

“This year saw significant differences in the returns of the bonds of individual countries,” the report said. “Russian debt, for example, sold off amid continuing worries about the economic impact of U.S. and European sanctions on the country.”

Indian bonds, though, saw impressive returns after the election of a reform-friendly prime minister. And local-currency bonds lagged those denominated in dollars or euros, the report said.

“We anticipate that the trend toward dollar strength will continue in the near term, creating a potentially attractive entry point for locally denominated debt in the coming months,” the report said.

Turkey will stand out

Taking a look at specific emerging markets, Turkey stands out as a sovereign that’s expected to see a strong 2015 as a result of growth prospects and an improving deficit, a London-based trader said.

Another trader said he favors Turkey’s Turkiye Sinai Kalkinma Bankasi AS (TKSB) and Turkiye Is Bankasi AS (Isbank), which have strong fundamentals and management.

The London trader is neutral on the Middle East and cautious on Russia, given that sanctions are expected to continue there into at least the second half of 2015.

“We expect EM technicals to remain key, with investors likely to remain nervous on Latin America and Russia, which could benefit Turkey and the Middle East,” he said.

From the Middle East, sukuk issues are expected to continue to gain favor among investors, and supply should be fairly plentiful, another trader said.

America Movil shows value

Mexico’s America Movil SAB de CV could be a good pick for 2015, according to a report from MUFG.

“Emerging market exposure is a risk factor for the name, but despite some deceleration AMX is exposed to more favorable drivers than many European names,” the report said. “We see value in both senior and hybrid bonds.”

Also from Latin America, Argentina is expected to make a comeback in 2015, a market source said.

Though the economy has sputtered following the sovereign’s default, a recovery could be on the horizon, opening up opportunity for investors who aren’t overly cautious, he said.

Asia in focus

From Asia, MUFG is favoring China-based Country Garden Holdings Co. Ltd.’s 2019s and 2021s amid good growth, diversity and leveraging.

China’s CIFI Holdings Group Co. Ltd. 2018s look solid for the company’s low risk of association with corruption scandals. And China-based Yuzhou Properties Co. Ltd.’s 2017s, 2018s and 2019s get high marks for credit quality, geographic exposure and a potential upgrade.

India’s bonds are expected to become more popular in 2015 as the country’s economy bounces back and after Standard & Poor’s raised its outlook, a trader said.

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