Market Views: Fixed Income
EMD Relative weekly notes
Week Ending March 4, 2016
The recovery in emerging market assets has been solidly supported by the rebound in commodity prices. Since the February 11th lows for seemingly every asset and asset class, copper prices have risen over 13% and WTI oil has risen over 23%. Year to date, sovereign dollar bonds in EM generally are up 2.73% and the local currency EMD index is up over 4%. One of the reasons we are comfortable that the rise in commodity prices is at least unlikely to re-trace, if not continue upward at a more modest pace, is the easing of recession fears in the US. The chart below shows the Citi surprise index, which measures where economic data releases come out relative to expectations. Interestingly, this chart bottomed a week prior to the rise in assets generally.
At least for now, the better US growth numbers come with only moderately-higher priced probabilities of a Fed rate hike. Should those probabilities rise further, it would potentially challenge a continued recovery in EM assets. But the US dollar, which we refer to as the single most important price 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 is the reduction of country-specific worries. China’s currency stability continues to be a comfort to the markets. The return of Argentina to capital markets after 15 years is also broadly a positive for the asset class in our view, as following the election of a president who ran on a sound economic platform, this country has aggressively tackled its economic distortions and is no longer a cautionary tale. This week in Brazil it appeared that President Rousseff moved closer to an impeachment attempt as her party’s leading figures came under closer scrutiny from corruption charges. 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 her removal—so markets responded positively to those developments. 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.
Lastly, investors are recognizing the better market tone after some delay: After outflows from emerging market debt funds that that topped $8 billion year to date, fund flows this week were the strongest since December with inflows of $346 million. In our view, this move suggests that investors are only now catching up to the more supportive factors now unfolding in emerging markets.