31 Mar 2023 2 min read

EM opportunities in a time of rising rates

By Matthew Rodger

Our EM sovereign spread model highlights where EM pricing differs the most from fundamental risks.


Only a few months into the year, and markets are in a delicate condition. Across developed markets (DMs), investors are undecided on the timing of recession, worried about central banks’ hiking spree and queasy about geopolitical tensions. Emerging markets (EMs) are always vulnerable as investor sentiment sours, with risk-off attitudes often generating crises in EM currencies and economies.

Risks to EMs are certainly rising. Real interest rates in both the US and EMs look set to break from the subdued equilibrium they’ve been stuck in since 2008. Now that DM central banks have doubled down on hawkish policy, the easy money that EMs have grown used to since 2008 has come to an end.

As liquidity conditions tighten, investors worry some EM economies will be left exposed.


Investor uncertainty is made worse by diverse EM performance. Central banks have been timid in Turkey, but bold in Brazil. Swings in commodity prices have aided Colombia but hampered Poland. Domestic growth is weak in South Africa, but strong in Indonesia. How can we reconcile these factors and produce a concrete fundamental picture of EM risk?

We use our EM sovereign spread model, newly developed within the Multi-Asset team, to answer this question. The model looks at the market measure of EM risk (sovereign spreads) and identifies statistical relationships between this perceived risk and movements in domestic growth, inflation, market volatility and external vulnerabilities. By grounding movements in market risk in fundamental factors, we can see which countries are within their risk limits, and which are living on borrowed time.

Looking in the (fundamental) mirror

Looking across the EM space (after adjusting for those countries affected by the war in Ukraine) EM credit looks fairly valued, in our view, untroubled by recent choppy financial conditions. Even modest deviations since 2009 have generally reverted to trend in time.


But beneath this aggregate view, the individual country picture is more mixed, some looking attractive, others richly priced. As financial conditions tighten and the era of cheap money ends, richly priced countries can deviate from these constraints for only so long. If markets perceive this deviation as permanent, richly priced countries risk the onset of crisis if sentiment does not improve.


Eye for talent: Selecting EM potential

Which EMs are testing market patience? Among the major economies where we invest, the Philippines, Malaysia and Brazil all look expensive. By contrast, Hungary, South Africa and Colombia all seem comparatively better placed.


To be clear, this model informs the investment strategy in the Multi-Asset team; we don’t take systematic risk in EM based on this model. Our conviction in our position in South African local currency bonds is strengthened, as we judge markets are overestimating fundamental credit risk in the country. Similarly, the fundamental case for our current long in the Hungarian forint is reinforced by the model’s perception markets are exaggerating fundamental credit risk in the country.

Matthew Rodger

Assistant Economist

Matthew is an economist covering emerging markets. He uses countries’ historical experience, alongside fresh economic data and quantitative methods, to recognise new investment opportunities. Prior to joining LGIM, Matthew graduated with an MSc in Economics from the London School of Economics and worked in various economic research roles. When not studying EM economies, he is enjoys reading, hillwalking and skiing.

Matthew Rodger