Fixed Income

EMD Relative weekly notes

Week Ending October 7, 2016

10/10/2016

James Barrineau

James Barrineau

Co-Head of Emerging Markets Debt Relative

Friday’s job number--just a touch below consensus--seems enough to continue to keep emerging market debt in its current "carry" environment without significant price movement in either direction. Local currency denominated assets, with their usual more amplified volatility, is in a similar holding pattern with nearly flat returns in the first week of the fourth quarter.

We don't see much to change that dynamic unless the upcoming US elections in November upsets markets. Market implied probability of a December hike now stands at 64%, so it’s difficult to believe that would come as much of a surprise, as Fed rhetoric continues to guide sentiment in that direction. It is also difficult to believe there is much of a hiking cycle beyond that, given soft economic data relative to expectations.continue to recognize that--we have averaged $2B in inflows into mutual funds since July with another strong number this week. The yield advantage that EM assets continue to maintain is a significant security blanket when compared to other fixed income assets, where small price moves will destroy returns swiftly due the miniscule income opportunity they possess.

Though EM has had a strong run, it is not remarkable at all in the global fixed income context. We remain continually surprised that investors do not appreciate this fact. The chart below shows how long-dated government bonds globally have fared, mostly out-performing EMD.  

Source: Bloomberg; data as of October 7, 2016. Past performance is no guarantee of future results. For illustrative purposes only. Does not reflect any actual portfolio. Other periods would have achieved different results.

So we can factually conclude that EMD has benefited from this QE era, but not disproportionally more than much of global fixed income. That is the past. Going forward, EMD still has a significant yield advantage with index yields hovering around 5% that we think enhances the probability of continued out-performance. We expect those yields to decline as investors increasingly recognize this.

The views and opinions contained herein are those of Schroders’ investment teams and/or Economics Group, and do not necessarily represent Schroder Investment Management North America Inc.’s house views. These views are subject to change. This information is intended to be for information purposes only and it is not intended as promotional material in any respect.