Co-Head of Emerging Markets Debt Relative
Our emerging market (EM) debt expert, Jim Barrineau, has been highlighting a number of positive developments for the asset class in his recent blog posts. This week he turns his spotlight on some fundamental factors that seem to be turning the tide for investors.
The recent recovery in emerging market assets has been solidly supported by the rebound in commodity prices. Since the February 11 lows for most asset classes, copper prices have risen over 13% and West Texas Intermediate oil has jumped by over 23%. Year to date, EM sovereign dollar bonds are up 2.7%*, while the EM local currency debt index has risen by over 4%*.
One of the reasons we are comfortable that commodity prices are unlikely to retrace this performance, even if they only continue upward at a more modest pace, is the end of recession fears in the US. The accompanying chart shows the Citi surprise index, which measures where economic data releases come out relative to expectations. Interestingly, this chart bottomed in February a week before the rise in assets generally.
Source: Bloomberg, 4 March 2016
At least for now, the better US growth numbers come with only moderately higher priced probabilities of a rate hike by the US Federal Reserve. Should those probabilities rise further, they could challenge the continued recovery in EM assets. But the dollar, which we see as the single most important factor for emerging markets, has not responded, and has actually fallen by a percent over the past week—further encouraging the rebound in EM currencies.
A secondary factor for the asset class has been the reduction in country-specific worries. China’s currency stability continues to be a comfort to the markets. The return of Argentina to the capital markets after 15 years is also broadly positive.Following the election of Mauricio Macri as president, who ran on a sound economic platform, the country has aggressively tackled its economic distortions and is no longer a cautionary tale.
Further north in Latin America, it appeared last week as if President Dilma Rousseff of Brazil moved closer to being impeached after her predecessor and fellow Workers’ Party member, Luiz Inacio Lula da Silva, was briefly taken into custody for questioning over corruption allegations. While the issue will remain fluid, there is a deep consensus that nothing will happen to break the political stalemate that has led to policy paralysis without President Rousseff’s removal, so markets responded positively to this development.
Elsewhere, Asian growth ex-China and Japan still seems solid, and Indonesia is emerging as a country that is capable of using both fiscal and monetary levers to boost growth with sustainable policies.
What is particularly noteworthy is that investors at last seem to be recognizing these improving fundamentals. The outflows from emerging market debt funds that have topped $8 billion so far this year reversed last week, with fund inflows of $346 million at their strongest since December. This suggests that investors are at last catching up with reality.
*JP Morgan Emerging Market Bond Index Global
**JP Morgan Government Bond Index-Emerging Markets