Stephen Rudman: Good morning and good afternoon. My name is Stephen Rudman. I am a member of the Ashmore New York city-based client-facing team. Welcome all. Hope everybody's summer is off to a great start. I know we've had all kinds of interesting hot weather and obviously all kinds of fun around the soccer, football, excuse me. So, again, hope everybody's having fun. 

But thank you truly for joining today's webinar: 'EM sovereign debt: The yields are alright'. We have our Global Head of Research, Gustavo Medeiros, and our Emerging Market (EM) EM Debt Portfolio Manager, Christian Schniewind, and beat me up for that, because I can't say it.

The discussions we'll cover today are broad, but also about opportunity in the space, which is most important. A little bit on global macro, which has been pretty dynamic. Key risks in the asset class, which is what concerns us most, either light or heavy, healthy yields despite tight credit spreads, which is an interesting opportunity, improving EM fundamentals, which has been an ongoing scenario for some time and we think will continue, but will be discussed in detail. And the two items that always matter, valuations and technical. So, those are the topics we'll cover, and we'll address questions at the end. 

With that, let me get out of the way. Gus, I will hand it over to you and have at it. Thank you.

Gustavo Medeiros: Thank you very much for the kind intro as always. Thank you, Christian, for joining your first webinar.

Christian Schniewind: Thank you for having me.

Gustavo Medeiros: Pleasure to talk to you. Maybe you should start with the EM Debt question that is on everybody's mind and we get in every single client meeting: the asset class has had a nice run and the fundamentals are pretty good, as Steve alluded to. We're going to discuss that a bit more. But credit spreads, boy, they're tight, aren't they. And putting some people to rethink their allocations, etc. What's your view on that?

Christian Schniewind: Yes, the first question I get at a client meeting is: “if spreads are tight, why should we be here”? And my response is always, in a way, they're tight for a reason. As you allude to, fundamentals have been improving and we've seen it over the last couple years with rating actions pointing predominantly towards upgrades rather than downgrades. And we have seen some sort of a convergence, quite frankly, between EM and developed markets (DM), and that's why we think there is a reason which doesn't detract from the fact that they are tight on a historical norm. So, definitely agreed with that. 

I think what's important to take a look at also the reaction you have observed over the last about of volatility when the war in the Middle East started. Normally, you would see a massive reaction for spreads during this environment, and actually it was relatively muted. In the investment grade (IG) space, we saw from peak to trough widening of about 20 basis points (bps). In high yield, there was 60bps, but they retraced very, very quickly. 

And in other episodes, we have seen much, much more of a reaction, more volatility. And again, that comes back to what I was saying is that the fundamentals have been improving and people feel more comfortable with the asset class. 

So, I guess from my perspective, the question is not if they're necessarily too tight, but what could cause them to widen quite substantially and make basically investors lose their capital? And from my perspective, geopolitics is always a risk, and so is a global recession, but I don't see these on the horizon in the near term. And as I've just alluded to, geopolitics wasn't the trigger of much volatility. What are your thoughts on that, Gustavo?

Gustavo Medeiros: In the piece that we just published, we go through these risks. But essentially, when you think about investing in this asset class, you've got to think about it as a long distance marathon runner, right? You know that you can outsprint it in the short term, you can invest in other asset classes that can go up 5%, 10% in a very short period of time, sometimes in a week or a month. But if you look at it over the very long term, it's very hard to outpace it, particularly with the kind of volatility that it delivers. 

And the reason for that is that you typically get what is the risk-free, is the spread over US Treasury or where the banks fund themselves on US swaps, plus a risk premium, and the risk premium is typically overestimated for various different reasons. But traditionally, as we look at it with our own client base, and in the survey and in the reports from the large endowment asset allocations of the world, there has been relatively small asset allocation vis-a-vis the characteristics of the asset class. 

Now, every 10 years or so, you can see that the asset class has a shock. And typically, what drives these big shocks are recessions or very sudden stop in economic activity. In a recession, you have credit spreads widening, particularly private sector corporate debt, because in an economic activity stop down, revenues collapse, and then the EBITDA (earnings before interest, tax, depreciation and amortisation) becomes negative sometimes, and then the debt-to-EBITDA increases significantly. 

If you try to extrapolate this shock over two or three quarters, you're going to have a number of companies that would have problems on rebalance or refinancing their debt, and then typically you start getting defaults increasing. And in that environment, credit spreads become very correlated, even though we are invested in a sovereign asset class, it should have a lower correlation with the private companies. There will be a number of sovereigns that are over-indebted and that are dependent on refinancing their debt. 

As you alluded to, the fundamentals mean that the number of compounds of sovereigns that need to refinance the debt within the very short term have declined significantly because of the improved fundamentals. But even if the fundamentals are better, a recession will drive that. Now, at the beginning of the conflict, we were really worried about, if you look at the major oil shocks since the 1970s, which was since we have data from oil prices, if I'm not mistaken, four out of the six major oil shocks in the past, you actually had an economic recession. And depending on how long this conflict lasted, and depending on the degree of the disruption, we can have a recession.

In our calculations, a major oil shock would mean oil prices going up to the USD 140 to 160 area and staying there for a couple of quarters. Luckily, or thanks partially due to the response of China, due to the response of the OECD countries, including the US, releasing reserves, despite the fact that it had a much more prolonged closure of the Strait than we though, we went nowhere near these levels. As a matter of fact, today, the oil money spot prices are trading in the mid-60s, actually below USD 65 today. The Brent versus future are just above 70, despite the fact that we are seeing every couple of days, or every three or four days, some skirmishes still happening on the Strait and the flows haven't been disrupted. 

Now, the other part of this is obviously, we are in a capex cycle because of the artificial intelligence dynamics, and this geopolitical shock means that actually there is going to be a need for much more capex in things like energy security, in pipelines in the Middle East, in defence, particularly in the Middle East, but also in other countries, and the supply chain diversification. 

So obviously, it's very hard to see recessions in advance, but usually you have one or two telltale signals that can actually say, "Okay, that could lead to a recession." Today, I think it's very hard to point to one. And if we're not going to see a recession within the next couple of years, because we're in the middle of a capex cycle, and by definition, these are cycles where economic activity accelerates or stays flat, then the big tail risk for an asset class is no longer there. That's why we can see credit spreads staying tight or grinding slightly tighter even from here. 

The second risk would be a regime change at the Federal Reserve (Fed), right? Because we pointed out in the piece where we look at the relationship between real interest rates and credit spreads, and we show that historically during most cycles, the relationship is zero or actually negative. Typically, real interest rates are increasing when economic activity is picking up, and this is actually positive for growth, positive for credit worthiness. And in that environment, credit spreads should tighten. But if we have a sudden reprice in real interest rates because of a change in reaction function of the Fed, say the Taper Tantrum event in 2013, then in that scenario you can have credit spreads widening. 

We already had, over the last six months or so, a very sharp increase in real interest rates. It was more pronounced on the front end of the curve because inflation expectations collapsed together with oil prices, but nominal interest rates increased marginally because of a perceived hawkish approach by the new Fed Chair Kevin Warsh. And therefore, one-year real interest rates or two-year real interest rates increased by more than 100bsps. But if you look at the five-year forward in interest rates in five years’ time, the real interest rates increased just very, very marginally and it just went to the top of a range. So, the cost of funding for these sovereigns that we're talking about that really matters is the five, 10, 30-year bonds, right? And therefore, the five-year, five-year real interest rates is the one that matters the most. Here we had a minor adjustment. I do not think that Kevin Warsh wants to rock the boat. I think that he wants to have a very hawkish communication stance to anchor inflation expectations and allow for these energy-driven disinflation to have more legs, but I don't think he wants to actually bring... he's no Paul Volcker, right? He's not going to increase interest rates quite significantly. 

And then the final risk is the risk of EM fundamentals deteriorating. As we discussed, they've been improving so far. We pointed in our 2026 outlook where regime change in Latin America was moving from far-left regimes to centre-right regimes. That is largely done right now. The big prize is Brazil, which is going to have elections in October and is a complicated picture. We pointed out back then, that it was close to a coin toss and hard to call, it remains like that. I think the market is going to start paying attention to Brazil’s elections within the next couple of weeks as the FIFA World Cup unwinds, and with Brazil being eliminated… Sadly, now, it's already started to you know, to make the waves. But largely speaking, in Latin America, that regime-change shift is playing out. 

And in Eastern Europe, we had a de facto transition of power in the Prime Minister of Romania recently, and now the elections in Hungary delivering a super majority in both houses of parliament in Hungary to a pro-European government with a platform of getting Hungary to adopt the Euro, And in order to do that, you must do a number of structural reforms that increase productivity growth, one of them being lowering the inflation target, which is positive. So, so far, the fundamentals have converged, EM fundamentals are improving, DM fundamentals are deteriorating, and there is nothing to make us believe that things can change very quickly, but it's something that we have to keep an eye on as well. 

Now, Christian, can you elaborate a little bit more on the nuance or the fundamentals that I've just mentioned, improving in EM and convergence to DM?

Christian Schniewind: I think you put your finger on it, really. What have seen over the last couple of years, certainly, in fact, probably more so for the last decade, is a convergence of policies in the sense that you have fiscal policy, you have monetary policy, which in EM are much more looking like they used to look like in developed markets. 

Broadly, institutional conversions is what we would observe here. And you already spoke about fiscal policy driven by ultimately changes in governments that want to do the right thing, that are much more attuned to what markets are saying, whether that's in places like Hungary, you mentioned as the most recent example, obviously extremely important to release EU funding, whether that is in places like Colombia, where we just had an election, Peru, Chile, Latin America more broadly. You mentioned Brazil, which is coming up. Here we've definitely seen an improvement in the policymaking. Now, not even talking about Argentina, obviously, which is a standout in terms of the way they've approached it over the last two years. So, that is really important, and you compare that to what we're observing here in Europe, for example, in the UK, in France, which is all but unreformable, policy uncertainty in the US, and you juxtapose that with what's happening in EM. That's quite telling. 

On the monetary policy side, I think you have definitely seen a conversion of the inflation targeting regimes. A lot of EM central banks have actually lowered their inflation targets over the last couple of years and are looking to drive that even lower. You know, Hungary, you mentioned again, obviously, they're looking to join the Euro down the road. In order to do that, they need to produce lower inflation numbers. You then have seen not only the targets moving, but also EM central banks actually reacting much, much quicker to inflation, which in the West was perceived as transitory. And as a result, real yields, which you highlighted earlier in emerging markets have outpaced inflation. They are now, if you're looking at the Global Bond Index at 4.9% versus inflation at 3.4%, so you're actually getting paid to take the risk in these local markets. And that is just permeating itself in the way that central banks are approaching policy. 

So, I would say all of that ultimately is responsible for the tightness in spreads, which we already talked about. What we haven't really mentioned yet, and I think that's what you can't lose sight from a value perspective is that yields and, Stephen, you said yields are alright, yields are still actually very attractive. If you look at the broad index level, they are above 6.5%, for investment grade, they're 5.6%. If you compare that what you're receiving in DM, the value proposition from my perspective is still there. And quite frankly, I don't really see many alternatives in fixed income. But what do you think about the value proposition of EM versus the rest of the world?

Gustavo Medeiros: Yes, it's a good question. And in the piece, we've highlighted a couple of things there. First, that the relative valuation, if you look at the EMBI high yield in particular, versus the US high yield, you can see that over the last 2.5 years, EM yields have been tightening, or spreads, you can look at it, they really won't make a difference because it's a very similar duration profile of both asset classes. But if you look at the trend, the trend is for further tightening to take place. Again, that goes in line with the fundamental dynamics that we mentioned, but it also goes in line with typically how the cycle plays out. So, typically, as things start to improve, first the yields tighten across the board, and then as yields starting to look a bit tighter, then you'll try to find relative value and try to squeeze more and more and more relative value out of two asset classes. So, there is still a lot of room in the high yield space in particular for credit spreads in EM to tighten to the developed world.

And this is a spot that we didn't mention too many times in this webinar, but we mentioned several other times in prior webinars. This is an area where most of the improvement in credit is actually taking place. A lot of countries that had defaulted in 2020–2022 because of the pandemic-era recession and tightening of liquidity, because they had to do massive structural reforms. And you mentioned Argentina is a classic case where they restructured, one of the first countries restructuring during the pandemic, now there was a transition of power to Javier Milei 2.5 years ago now, and then suddenly the country moves from a fiscal deficit of 2–3%, to a primary surplus and an overall budget surplus, right? 

So, Toto Caputo, the Finance Minister of Argentina, is talking about the target of becoming investment grade by 2031. It's not pie in the sky if they keep this fiscal policy tight as it is. And if the external accounts keep on improving in line with the increase of energy, increase of agriculture, increase of mining production that is happening, now it's an investible country with a much better, more sensible environment for investment after a lot of structural reforms, then the credit worthiness of the country is going to improve quite significantly over a multi-year time horizon. 

Many examples in Africa, many examples in other places, right? So, when you compare that again with what I mentioned is the marathon runner, the long distance runner, I think, is a good analogy to think about it and compare it with the equity market, right? Because, if you look at asset allocation over the last five years, the main trend that is taking place is people are looking at the 60/40 portfolio and saying, "This really hasn't worked, because over the last five years, we’ve had a massive bear market in bonds, and this 40% that were supposed, or 60%, the bonds parts of the asset class that were supposed to protect my portfolio and provide some income hasn't been doing its work." 

So, they've been migrating to things like gold, commodities, crypto, etc. I think there is good reason to have some commodities in portfolios, and I think it makes a lot of sense. But I think given where valuations are today, particularly of gold specifically, I think that the allocations to that space went potentially a little bit overboard. If you think about it from a five-year return, total return perspective, you get an asset class that can deliver a 6.5% total returns with a relatively small volatility, like EM sovereign that offers today, that's a very hard to beat, right? Gold pays you no income, no yield, and if people decide to sell gold tomorrow, then gold prices are going to have to come down. There are many reasons why it potentially could go down, but I think from a total return perspective, I would make the challenge that a 60/40 yield portfolio would outperform gold hands down, and I think that the fixed income on itself does it as well. 

And again, comparing with the S&P 500, you cannot compare because S&P has earnings and earnings growth, and expectations of earnings growth in the future, which drives re-rating or de-rating. But today, what we have is the price-to-earnings at the highest, cyclical highest, close to 2001. Earnings growth is also very close to the cyclical highest point, and expectations for earnings growth is at the highest level since 2001. So, the market is very close to priced to perfection, if you will. And the total returns on a long-term basis following these kind of valuations, they tend to be quite poor if you look at it over the long term. And that's where I think the comparison makes sense. 

I think that more investors should be thinking about having assets that will diversify their portfolio on a geographical basis, on an asset class basis, and will pay you actually a pretty decent income. So, if you look at the earnings yield on the S&P 500 today, which is inverse of the price-to-earnings basis, EM sovereign debt offers more than 300bsps pick-up to that, which is actually one of the widest levels in history. So, it's attractive on a number of ways of comparison, and that's why I think it will continue to attract investors' interest. When people think those spreads are very tight, that's fair enough, but you calculate the total returns on the basis of what is the initial yield that you get today minus eventual default, right? Ultimately. And the marked-to-market risk is simply what we discussed: either we're going to have repricing of the Fed, etc., if the defaults are going to be low, and at the moment, there's nothing to suggest we're going to have a recession, which typically drives the default cycle, then I think we're in a good space. What we didn't discuss so far is the technicals. Where do we stand here?

Christian Schniewind: You alluded to it. This is an asset class that has gone through very difficult times in recent years. And when I say that, I mean particularly post-COVID. And if you look at the issuance picture from February 2022 to basically December 2024, we had negative net issue. It's really capital being withdrawn from the market. That has changed in 2025, and it's definitely also changed in 2026. If you just look at January, the biggest or strongest months in external debt issuance ever was USD 70bn. That continued, you know, seasonally, January, February are strong, but then obviously there was a complete drop off in March with the Iran war. But since then, we've seen more issuers come to market again, and we're now just over USD 160bn in issuance, about halfway where the market sees we're ending the year. So, the backdrop has been good for issuers, but more encouragingly, the reception for investors has been excellent.

So, even though we've seen a lot of issuance, for example, coming out of the Middle East post the Iran War, or the Memorandum of Understanding, these has been received very, very well. And obviously, spreads haven't widened on the back of that at all. So, from our perspective, we think, and if you look at the overall flow picture, obviously, we've seen, again, after a couple of difficult years, year to date, we're about USD 28bn of inflows into external debt asset class, that's for funds. That means that the asset class is attractive. People are looking to diversify out of, for example, US IG and Emerging Markets IG, and the spreads are, as we discussed already, substantially similar. And we think that is something that can continue, quite frankly. Again, also, if you look at the rating actions, which I started off with, that picture hasn't changed at all, and we do think that that is a development that they can continue.

Gustavo Medeiros: Very good. And in relative terms, there's a number of companies in the US that were generating a massive amount of free cash flow. Now they're at the forefront of this capex cycle that I mentioned, and their free cash flow went all the way to zero now. The hyperscalers’ free cash flow went from USD 450bn per year to literally zero on a 12-month forward-looking basis. And a lot of those are issuing equities and issuing more debt. So, you're going to have more issuance in the developed world, which I don't think is going to be an overwhelming deterioration with the technicals for DM and for fixed income in general, but it will definitely add more pressure in relative terms in the technicals in the US and the developed world space in EM.

Gustavo Medeiros: So, well, I think that's that covers most of the topics. Maybe a very, very quick wrap up of what we discussed. We are talking about an asset class here that typically delivers very, very long-term total returns and with a steady profile of volatility, except for various, except for recessions, right? And with the current global macro environment today, capex cycle-led growth dynamics is really hard for you to foresee an economic recession, particularly after dodging a massive geopolitical bullet in the sense of the Strait of Hormuz dynamics. 

The second-round effects from the energy price shock that we saw have not really been seen on inflation, and energy prices themselves already, or oil prices, crude oil prices specifically, already round-tripped. The issue so far is obviously the products, the refined products, gasoline, diesel, jet fuel, they still remain elevated, but that's as a result of the supply chain problems that you have created as a result of the shutdown of the Strait of Hormuz for four or five consecutive months. 

Over time, we think that those would likely converge downwards given the supply of oil that seems like we're in a glut today. So, there's a lot of disinflation ahead, and it doesn't seem we're going to have a structural shift in terms of the reaction function of the central bank. If anything, this disinflation allows them to talk hawkish and do very, very little. The European Central Bank hiked once, the Bank of England is not keen to hike at all, the Fed is trying to be very cryptic about it, but we know that Kevin Warsh’s instinct is not going to be to get a new Paul Volcker. He actually has been mentioning time and again, before and now just after joining the Fed, that productivity gains can allow for these dynamics where you have inflation slowing down despite of the fact that economic activity remain elevated. 

Artificial intelligence certainly could allow for that, and it could actually have, particularly if it has a stronger impact on the labour market, which we see already plenty of signs, and that was really the thesis behind our ‘Goldilocks’ dynamics in 2026, which was derailed by the conflict, but not really ended. So, in this kind of an environment, this asset class still makes a lot of sense, and I think that there will be continuous demand for that. 

Do we have any questions from the audience, Steve, or should we wrap it up?

Stephen Rudman: No, indeed we do. I think everything was answered except for this one, which is very specific, so I will read it specifically. So, simply, Brazil, on the local side, front-end yields are high, nominal and real, given inflation. Do you think this is justified or an interesting opportunity? That's verbatim.

Gustavo Medeiros: I think it's both justified and an interesting opportunity in a way. It's not really the focus of this asset class in particular, but inflation expectations have remained relatively elevated vis-a-vis the central bank target. 

We mentioned several countries have lowered their inflation target over the last couple of years, one of them was Brazil, which is trying to bring inflation downwards with a government that has kept on doing more fiscal stimulus either directly or indirectly via the state-owned banks and keeping economic activity more or less slightly above the neutral level where economic activity would be without this fiscal action. 

So, this procyclical fiscal stance from the Brazilian government is one of the reasons why inflation expectations remained relatively de-anchored and inflation itself is still not at the centre core of the central bank target. There was a transitional change in the Governor of the Central Bank of Brazil (BCB) about 12 months ago, which was well executed, but the new Governor wanted to establish his credentials and hike policy rates quite aggressively to 15%. 

They started an easing cycle that should have lasted a little bit longer. They should have cut policy rates by at least 200 basis points, maybe 300 basis points, but were interrupted by the conflict, the shock in Iran. And with that, inflation expectations, again, had another leg higher. So, I think that the BCB is going to keep policy rates at relatively tight levels until we the energy-led disinflation that I've mentioned taking place and then they resume that is in cycle. 

The big question mark is what the next government is going to do. We're going to have an election in October, a new government in place in January this year, and if there is a transition of power to somebody that has a large amount of credibility and announces a credible set of actions in terms of economic policies to tighten the fiscal accounts, then I think that the real interest rates on a forward-looking basis can decline relatively quickly and inflation expectations can come down together with that.

And on the back of that, the BCB would be able to cut policy rates faster into a more aggressive stance. If Lula wins a fourth term and he doesn't come with a very forceful, very credible plan to consolidate the fiscal accounts relatively on a front-loaded basis, then interest rates can remain elevated for longer. But you're still capturing this 14% carry, which has been actually enjoying an extra benefit of currency appreciation over the last 12 months or so. 

So, Brazil is a carry story and it can be a massive capital gain story on an interest rate and currency basis, depending on the political dynamics, depending on whether we have a transition of power, or in the absence of transition of power, if Lula manages to find credibility that he found in his first mandate, but then he lost on the second, and had completely foregone on the third. That would be the most important dynamics, I would say. But the race is wide open, there's a lot of moving parts there. It's almost like it's another two to five minutes part of the conversation, but I think it is an opportunity. For now, it's a carry opportunity more than something that it's pretty obvious that you're going to have a lot of capital gains, but there is a non-negligible, let's say, 40% to 50%-odd scenario where you have a political transition, and in that scenario, they have quite large capital gains. So, the total return across scenarios is actually quite appealing.

 

Stephen Rudman: Awesome. Thank you, Gustavo. Gustavo and Christian, thank you very much for your time today. Again, I think often in the EM space, and obviously with the equity side of the markets delivering such big returns, often investors put the debt to the side. And our messaging, I think, here overall, is don't. There's an opportunity here as you look to diversify your holdings globally. 

I think what we've gone through today is that both the fundamentals and the technicals really leave for an intriguing scenario that over time here, not a trade, can be a nice addition to that re-modified or rejiggered, if you will, asset allocation that the world seems to be engaged in, and may be engaged for a long time. 

To all attending, thank you so much for joining today. As always, we appreciate your time. If there are any questions you have remaining, feel free to reach out to your Ashmore representative. More than happy to take the time and get you all the data and the information you need. Finally, we will send out a follow-up email, which will have a replay. We welcome you to share it with colleagues that you think may find this worthwhile or interesting to their routine. 

Gustavo, Christian, thank you. Thanks for the audience. All the best to everybody, enjoy the summer, and this shall now end our webinar of the day. Thank you.