November 22, 2017 / 5:17 PM / a year ago

JP Morgan sees 7-8 percent gain for EM debt in 2018, but road could be bumpy

LONDON (Reuters) - The prospect of another year of solid global growth should see emerging market debt make 7-8 percent in 2018, U.S. investment bank J.P. Morgan said on Wednesday, although it could be a bumpy first few months.

A J.P. Morgan building is seen at Canary Wharf in London, Britain May 17, 2017. REUTERS/Stefan Wermuth

Laying out their top ten themes for emerging markets, the bank said a packed calendar of elections including in Mexico, South Africa, Brazil and Pakistan could also enliven markets, while EM bond investors would see hard-currency debt in circulation top $1 trillion for the first time.

A rise in pan-EM growth to 4.8 percent, or 3.6 percent excluding China, and inflation only just creeping above 3 percent should keep the recent rally firmly intact however.

“For EM credit, we see 7 percent returns for sovereigns and 6 percent for EM corporates coming from carry and around 50 basis points of spread tightening in both to counteract the impact of rising U.S. rates,” J.P. Morgan’s analysts said.

“We see EM FX as likely to go through a few periods of rally and sell-off versus the dollar, as the improved EM fundamental picture is buffeted.”

A number of milestones should also grab attention.

Cheap borrowing costs are expected to see EM sovereign hard currency issuance of $136 billion (£102.3 billion) which will push the total outstanding debt stock above the $1 trillion mark.

And though overall inflows into EM debt may ease to around $80 billion from this year’s record $110 billion, demand for assets including Chinese bonds is expected to see ‘local’ currency inflows top ‘hard’ currency inflows for the first time.

“We will be looking to buy dips in EM local markets and expect a grind tighter in EM hard currency spreads.”

EM local bond net issuance meanwhile is forecast to increase by 4 percent year-on-year and EM corporates gross issuance is expected to total $442 billion, matching the record pace of 2017.

By country, J.P. Morgan’s analysts said they were cutting their Mexico recommendation to medium weight (MW) from overweight (OW) and rotating into Egypt.

They kept modest OWs in Europe and Africa, including OW Ukraine and Kazakhstan versus underweight (UW) Romania and South Africa, and OW Ivory Coast versus UW Gabon.

In Latin America, it was OW Argentina, Brazil and Pemex versus Peru and Bolivia, whereas it was UW EM Asia through Pakistan and Petronas.

“Within EM corporates, we are OW Latin America, Neutral Asia and EM Europe against UW in the Middle East. Latin America has the greatest scope for fundamental improvement and highest yields among the regions,” they added.

Reporting by Marc Jones; editing by John Stonestreet

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