Relative doves and EM probabilities 

• We think the message from Jackson Hole is that, relative to other developed central banks, the Fed will be the most dovish in letting economic growth run hot and could become even more dovish in the continued absence of inflation.
• This raises the probability that we are in for an extended secular downtrend in the US dollar, all other things being equal.
• EM currency, our choice for the out-performing part of the opportunity set for the next 12 months – have begun to take notice.

Figure 1 shows the returns of IG and HY dollar debt versus the local currency index and the S&P 500 Index over the last three months. IG has begun to flag given the negative bond response to the Fed; even so IG spreads have re-traced all but about 37 basis points of the pandemic widening. HY spreads have followed strong global risk appetites nicely, while currency has lagged. 

Figure 1

Source: Bloomberg, as of August 31, 2020. Charts measure the total returns of the investment grade and high yield components of the JPMorgan EMBI Global Diversified Index, the JPMorgan GBI-EM Broad Diversified Index, and the Standard & Poor’s 500 Stock Index for the period of June 1, 2020 through August 31, 2020. Past performance is no guarantee of future results. Performance for other time periods would differ.

Figure 2 shows what has happened with major EM indices around and post-Jackson Hole. The fallout from the Fed seems to be that currency under-performance among the EM opportunity set has a high probability of reversing.

Figure 2

Source: Bloomberg, as of September 1, 2020. Charts measure the total returns of the investment grade and high yield components of the JPMorgan EMBI Global Diversified Index, the JPMorgan GBI-EM Broad Diversified Index, and the Standard & Poor’s 500 Stock Index for the period of August 23, 2020 through September 1, 2020. Past performance is no guarantee of future results. Performance for other time periods would differ.