Long-term fundamental drivers for emerging markets debt show signs of improvement. Macroeconomic fundamentals have gradually improved with significant political reforms in key markets, tighter fiscal budgets, healthier current account balances, and strengthening growth prospects, which argues for long-term support and sponsorship as investors gradually address underinvestment to emerging markets assets. The asset class continues to offer materially better carry over developed bond markets, which provide low yields and are exposed to meaningful political uncertainty.

Technical factors are relatively balanced as asset class outflows have moderated into the start of 2017. However, a sharp or unexpected move higher in U.S. Treasury yields could prompt additional market outflows and reduced demand for fixed income over the near term. Political and economic risk in developed markets may lead to some volatility in 2017, particularly heading into several European elections and as possible aftershocks of the Brexit referendum are felt in developed Europe. Similarly, as details about U.S. President-elect Donald Trump's policies are clarified, some markets could experience an uptick in volatility. We see a modest renegotiation in trade agreements rather than a significant change in policy as a long-term result.

China's economic adjustment is a key global risk to monitor. We expect growth to slow toward a more sustainable long-term trend, but high-frequency data prints are likely to show volatility amid weakening effectiveness of government stimulus and capital controls.

Against this backdrop, we continue to favor hard currency emerging markets sovereign and quasi-sovereign debt given better relative valuations and liquidity. Select long-term idiosyncratic reform stories also offer compelling investment opportunities, particularly within Latin America, which can catalyze spread compression and credit rating upgrades. Frontier market exposure is centered on countries with solid fundamentals and good market liquidity, including Zambia, Sri Lanka, and Jamaica. Non-benchmark external corporate debt remains an important part of the opportunity set, but positions must be sized appropriately given the sector's lower liquidity. Quasi-sovereign debt has similar positive fundamental drivers but generally higher liquidity, making it an attractive alternative to corporate issues.

Local markets offer attractive yields and more supportive technical factors, with some countries also benefiting from improved inflation outlooks and increased prospects for rate cuts. We maintain a preference for countries that have positive reform momentum and limited currency risk through non-U.S. dollar funding sources.

As always, the diverse backdrop of idiosyncratic fundamental developments drives the importance of bottom-up country selection and a long-term investment view.