Do global fund flows point to further recovery in EMD relative?

Markets appear to have recovered some of their poise recently. Emerging market debt (EMD) relative specialist James Barrineau, argues that a number of fundamental factors suggest this is more than just appearances.

24 February 2016

James Barrineau

James Barrineau

Head of Emerging Markets Debt Relative

The market has been showing definite signs of recovery from its jitters at the start of the year.

Since the February 11 market lows, the S&P 500 equity index is up about 5%, while emerging market sovereign debt dollar spreads have tightened by about 41 basis points (both as of 24 February, source: Bloomberg).

Liquidity flows

When market sentiment improves like this, it is easy to point to the factors that in retrospect looked sure to be the drivers.

But one factor remains of paramount importance to us, and that is liquidity flows. When they change for the better, asset prices rise. Whether with a bit of a lead or a lag, this is a solid rule.

The chart below compares the sovereign dollar bond index with changes in aggregate foreign exchange (FX) reserves for a number of key EM countries (excluding China), which represent a good proxy for investment flows into and out of emerging market assets.

The course of these indicators over the past 12 months or so has been interesting. In 2015, after a disappointing January for asset prices, the bond market rallied until April, then began a steady sell-off which has continued until recently.

EM reserves have tracked the market changes pretty well over that period, so the recent sharp rise is striking, suggesting as it does that recent market gains are continuing to consolidate.

Certainly, the three key investment themes we have discussed at length already this year remain intact, and have probably been strengthened by recent news:


Currency stability seems to be leading to a reduction in the perceived threat of tail risks from China.

The Chinese renminbi has appreciated by about 0.6% since the interview given by Zhou Xiaochuan, the Governor of the People’s Bank of China on February 15.

It looks like Chinese policymakers have heeded warnings from investors (including ourselves) that they needed to get better at communicating with markets.

The recent sell-off in the currency is looking more or less like a repeat of last August, when an ill-fated sharp currency depreciation led to global “risk-off” for a number of weeks.


The oil price seems to be stabilising. The market quickly discounted an agreement between the Saudis and Russians to leave production unchanged, but we think it was significant for two reasons.

  1. If the agreement is upheld it will effectively result in a reduction of Saudi exports this summer, when the country’s domestic demand increases seasonally by about 500,000 barrels a day.
  2. While we remain sceptical about the chances of achieving a broader deal, the Saudi-Russian accord seems like a necessary precursor to getting Iran on board through some more complicated deal that takes into account the lifting of sanctions and the need to increase production there.

In the mean time, future supply reductions looks to be well on track, as the US rig count continues to decline rapidly and debt-financed production disappears.

Monetary policy

Finally, major central bank monetary policy differences appear to be narrowing. US economic data still seems soft enough to keep the Federal Reserve’s (Fed) plan to continue raising interest rates at bay, given the poor market reaction to December’s move.

At the same time, the latest estimate from the Atlanta Fed predicts current quarter GDP growth of 2.6%, so a plunge into recession also seems unlikely.

We await news on the further loosening of ECB monetary policy next month but, with the Fed effectively “out of play” for now, the dollar index has continued to tread water.

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