Argentinian bonds rallied on Monday, after debt-restructuring specialist Martin Guzman was named as economy minister in president-elect Alberto Fernandez’s government, prompting relief about forthcoming debt-restructuring talks.

Despite being buffeted by various idiosyncratic crises – bonds not only from Argentina but from Ecuador, Lebanon, Venezuela, and Zambia currently trade at distressed levels (i.e., their bond spreads are north of 1,000 basis points) – hard currency emerging market (EM) sovereign bonds have delivered a total return of almost 13% this year.

This year’s performance can be attributed both to declining benchmark interest rates and to tighter spreads. While we do not expect a repeat performance next year, we think EM bonds will be one of the more attractive fixed income investments.

* We expect spreads and benchmark rates to trend sideways. US 10-year interest rates are now almost 100bps lower than they were at the beginning of the year. A further sharp decline appears unlikely, especially if the US economy avoids a recession, as we expect. Similarly, spreads also tightened by almost 100bps this year. But this still leaves investors with the returns from the interest rate carry, which currently stands at 5%, more than 300bps above that of more defensive, high grade bonds.

* The growth differential between developing and developed markets (DM) will widen further in favor of emerging markets, in our view. We also expect the US dollar to weaken, which should bode well for EM credit fundamentals.

* A comprehensive resolution to the US-China trade dispute could spur global growth, creating upside for our spread forecast. Equally, a re-escalation of tensions would increase the risk of global recession and widen spreads on EM bonds. But in this scenario the Federal Reserve would likely cut rates, limiting the downside.

We are overweight USD-denominated EM sovereign bonds in our global portfolios. Despite our encouraging outlook for growth dynamics in EM relative to DM, we caution against getting too optimistic about the fundamental outlook for the asset class. In absolute terms, economic growth remains subdued, and among EM sovereigns we see more issuers with a negative than a positive outlook. That said, rating agency concerns center on a handful of countries, including Colombia, Mexico, South Africa, Turkey, and Uruguay. Various distressed issuers across Asia, CEEMEA, and Latin America are an important reminder that selectivity will remain paramount in 2020.