After a significant sell-off, we close our bearish view on EM and shift into neutral gear.

We remove our bearish call on EM fixed income and FX. We think this remains a difficult world for EM but we’ve likely adjusted enough for now. Most investors expect trade issues to escalate and so this is priced in to an extent. The policy response has picked up and DXY should weaken. UST is a risk.

Calling time on the sell-off: EM assets rallied strongly last week and we think this marks the beginning of a period of stability and range-bound markets for EM. We turn neutral on EM local markets and credit and increase our exposure to a number of high yielders.

Global risks moderate: One key risk for EM has been our expectation for DM assets to come under growing pressure. Our equity strategists see a lower chance of US stocks dropping now and risks of a move to 3000, so the ‘rolling bear market’ is on hold. The move in global markets last week suggested that high risk premia for trade issues are embedded in EM assets.

To be sure, we expect trade tensions to continue escalating and the US could announce its intention to put tariffs on the remaining US$267 billion of goods imports from China soon, but this should not be a surprise. The bigger risk is UST yields.

EM risks recede, while the policy response picks up: We previously highlighted a number of idiosyncratic risks in EM that could pose a challenge for EM over September. Risks have receded here at the margin but Brazil’s election is probably the primary concern.

The timetable for additional sanctions against Russia looks tight while the timetable for South African land reform has been pushed back, a market positive. The policy response from EM central banks has also picked up.

In local markets, we increase our exposure to high-yielding FX by raising Argentina, Indonesia and Russia to like, and removing the dislike on Brazil. In local rates, we move Mexico rates to like and remove the dislike from Argentina, Brazil and Russia.

We recommend short MXNRUB, KRWIDR and USDCLP positions. Overall, we see the case for local markets as stronger than credit, considering better positioning, valuations that are more consistently cheap across countries and expected USD weakness.

In sovereign credit, we expect spreads to tighten in the coming weeks even if already somewhat rich IG spreads and the potential for increased supply are likely to limit the extent of any rally. Amid a still broad-based preference for IG, we nonetheless increase the beta in our portfolio.

We recommend rotating out of Qatar into the higher-beta Oman, recommend adding risk in Mexico via Pemex and think Argentine spreads can tighten further. We also still like Russia, Colombia and Chile and think South Africa can tighten further. New trades are sell Qatar 26 vs. Mexico 26, buy Pemex 2047 vs. Mexico 2047, buy Argentina 2026 vs. Argentina 2048 and sell Brazil 5Y CDS-bond basis via Brazil 2025.


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