UBS Global Strategy: EM Strategy — Will Oil Break EM Credit?
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Since the onset of the Iran conflict, emerging market credit has demonstrated notable resilience, declining only 3.3%, which outperforms both MSCI emerging market equities and local-currency bonds. However, UBS scenario analysis highlights significant downside risks. Should the Strait of Hormuz blockade persist through late April, Brent crude prices could surge beyond $150 per barrel. Under this prolonged disruption scenario, EMBI Global Diversified spreads could reprice wider by 70 to 80 basis points, driving a full-year total return of approximately negative 9%. Conversely, an early April resolution would yield a positive 4.4% return.
Current valuations appear stretched, with EMBI GD spreads exceeding fair value by over 100 basis points. Additionally, debt service costs have risen to 3.5% of GDP, up from 2.5% in 2021. While balance sheet metrics have improved since the 2022 energy crisis, tighter fiscal positions and richer valuations increase vulnerability.
UBS identifies Central and Eastern Europe as particularly exposed due to challenging fiscal starting points and negative rating outlooks. To navigate these risks, UBS recommends overweighting a basket of oil exporters, including Angola, Nigeria, Azerbaijan, and Oman. These nations stand to benefit from current account improvements even under a base case Brent price of $86 per barrel. The strategy also favors short-duration positioning, as bonds with maturities under five years have historically outperformed longer-duration assets during negative index return years. UBS advises underweighting Poland, Egypt, Indonesia, and Kuwait, while closing the Romania long position.