Carmignac P. EM Debt: Letter from the Fund Manager

The second quarter has been characterized by strong bullish sentiment in risky markets as well as higher global rates. The 10-year Treasury went from around 3.5% to over 3.8%, while the MSCI World added 3.7% of performance.

In this context we have benefitted from the Local Rates rally in the CZK, HUF, MXN and BRL curves. Following the rally, we started to reduce as large interest rate cuts are starting to get priced, and the usual correlation between DM rates and these Local Curves seems to have broken during this quarter. In particular we have reduced the CZK, BRL and MXN rates. In the FX space we continue to enjoy the carry and performance of EM FX currencies. Like in the previous quarter we have been long HUF, CZK, BRL, and MXN. During the quarter we reduced our HUF after its strong rally and as the central bank started to cut rates at a steep pace. We also used the weakness in ILS and ZAR to enter into tactical positions. For sovereign credit, following the strong performance of the high yield (HY) we took the chance to reduce the exposure of the fund while keeping our more investment grade (IG) names. Another important event was our purchase of Turkey credit default swap (CDS) to protect the book but which paid off as Erdogan won the elections where we also reduced the protection.

Looking forward to it, we still expect a recession to hit the global economy: high rates are eating at demand and effect we are already largely seeing it in the EM world. Furthermore, China which last quarter was seen as launching a potentially large stimulus to boost growth, is showing that it is unwilling to repeat the policies of the past thus removing a possible source of global growth. This view of recession and high rates is reflected in our portfolio construction, namely a large reduction of risk assets. We also remain focused on duration with the view that a recession would force DM central banks to cut rates and thus enable further cuts in the EM world. This leaves us with EM FX which offer carry while having a central bank ready to defend the currency such as the CZK and the INR, as well as tactical/opportunist investments. In Local Rates we are ready to re-engage in the hikers notably in the BRL or HUF once the FED or ECB have paused and EM central banks can accelerate their cutting cycles. In Credit we remain cautious with protection against our HY names and will keep our positioning light and focused on the IG space.