Local currency rates and FX screen very attractive, while hard currency credit is neutral+.
Hard currency debt valuations:
- Credit Spreads: Neutral+
- The current excess spread of 170 bps is in our second quintile of attractiveness
- Historically, an excess spread in this second quintile has been associated with a subsequent mean 2‑year annualized credit return of 1.0% (above the risk-free rate)
- This implies a valuations-based neutral+ assessment
- USD Rates: Neutral+
- Our “deviation from fair value” for USD interest rates (page 9) shows an improvement in the attractiveness of USD duration, with current levels slightly above fair value
Local currency debt valuations:
- FX: Very Attractive
- Our expected spot return indicator lands in the most attractive fourth quartile
- Mean subsequent GBI-EMGD weighted spot return has been +8.7% for the fourth quartile and +7.1% for the third quartile
- Local Rates: Very Attractive
- EM local rates maintained an attractive valuation gap versus U.S. interest rates
- At 0.4%, this is in our most attractive fourth quartile, where the mean subsequent EM/U.S. return differential has been +2.6%
Tariff tantrum takeaways:
- State of valuations going into “Liberation day”:
- Hard currency: Spreads and U.S. rates were at neutral+ levels
- Local currency: Both FX and local rates were very attractive
- Post announcement – as we did with the COVID shock, we performed some top-down scenario analysis around the metrics we use in this report:
- Hard currency: Our sovereign team stress-tested our 90-country opportunity set for two downside scenarios – a "moderate” downside and a "severe” downside. We considered two channels of impact from the trade war: (1) a U.S. recession, particularly affecting those countries with high economic integration (and trade) with the U.S.; and (2) a global risk channel that chokes funding to EM countries, exposing the most vulnerable to rollover risks.
- In the moderate case, 27 such countries (39% of EMBIG-D) are downgraded, while the severe case doubles down on these downgrades and adds 5 countries (an additional 12% of EMBIG-D) to the vulnerable list.
- The output is a change in the expected credit loss from default, which rises from 119 bps at 3/31 (as noted on page 5) to 149 bps (moderate) or 177 bps (severe). The actual duration-adjusted EMBIG-D market spread rose from 288 bps at 3/31 to 308 bps at 4/10/25.
- Hard currency: Our sovereign team stress-tested our 90-country opportunity set for two downside scenarios – a "moderate” downside and a "severe” downside. We considered two channels of impact from the trade war: (1) a U.S. recession, particularly affecting those countries with high economic integration (and trade) with the U.S.; and (2) a global risk channel that chokes funding to EM countries, exposing the most vulnerable to rollover risks.
- Local currency: Unlike hard currency credit, where it’s reasonable to expect weak countries to get weaker, local debt deals predominantly with relatively strong countries with already undervalued currencies (so far, few EM currencies have recovered spot FX losses from Q4 last year). Moreover, the impact on growth, inflation, and financial flows is complex. We are therefore still debating whether we can meaningfully stress test the variables of our FX and rates valuation metrics.
Download article here.