In Q3, positive market sentiment helped risk assets post strong returns in July and August, boosted by the continued support of central banks. Macro indicators, such as the Purchasing Managers’ Index (PMI) fell in September as the of the service sector suffered from second wave lock-down restrictions, which weighed on investor sentiment.
Within EMs (emerging markets), economic activity continued a gradual rebound, benefitting from a strong reopening of the manufacturing sector, particularly in Asian countries where COVID-19 cases continued to decline. In August, manufacturing PMIs in EM countries peaked to their highest level since March 2011, even outperforming developed markets on a relative basis. After surprising to the upside in June and July, inflation levels moderated in August. The result was a somewhat less dovish outlook from central banks and an upward trend in EM bond yields.
Quarterly performance analysis
EM fixed income sectors posted positive returns in Q3. At the hard currency level, directional positioning was beneficial, as strong investor sentiment gave way to significant spread tightening. Local currency (LC) positioning and EM foreign exchange exposure also contributed positively to performance. The Fund benefited from overweight exposure to high yield bonds, which rallied against a positive macro backdrop. However, some of these returns were lost in the second half of the quarter as investor sentiment deteriorated due to uncertainty around the upcoming U.S. elections and a second wave of COVID-19 outbreaks. This risk-off backdrop supported the exposure to higher quality investment grade credits, such as Indonesia. The Fund’s performance was negatively impacted by overweight positions in Ukraine and Bahrain, and by an underweight in Colombia.
On the EM local rates side, the Fund benefitted from an overweight in Mexican government-owned oil credit, and overweight positions in Romania, Malaysia, and Turkey. Russia was a key underperformer in the local rates side due to the rubble’s (RUB) depreciation during the quarter. The Fund reduced its overweight in South Africa, as its economy was one of the worst hit by the COVID-19 pandemic and the country has a significant fiscal deficit. The fund increased its underweight to Ghana given the fiscal deterioration of the country and reduced its exposure to Indonesia, Philippines and Colombia due to tighter valuations.
On the EM LC side, the Fund trimmed exposure selectively during the quarter as the portfolio manager expects EM central banks may have fewer monetary levers remaining to support their economies.
After a strong rebound in global growth in Q2, the recovery in Q3 appears to be flattening. Globally and within EMs, the pace of recovery in the manufacturing sector has stabilized. Amundi remains cautious, as market sentiment has rebounded despite the continued spread of the COVID-19 virus and a vaccine yet to be available. The portfolio manager’s outlook for EMs remains fairly positive amidst ample global liquidity. EM central banks have provided extensive economic support through rate cuts, which have been far more aggressive compared to other easing cycles. Financial conditions in EMs have tightened recently and yield curves are now steeper. Central banks will be limited in their ability to cut rates further going forward as inflation has begun to rise in some economies, but may continue to use other unconventional policies to support economic recovery. In terms of risks, in addition to potential headwinds from a second wave of COVID-19, Amundi believes uncertainty around the outcome of the U.S. election is a key risk to monitor in the coming weeks.