EMD Relative weekly notes

James Barrineau

James Barrineau

Head of Global EMD Strategy

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With the Fed’s recent rate hike, we are probably about 75% through this rate hiking cycle, according to market pricing. The peak effect of fiscal stimulus is increasingly behind us, and the negative growth effects of the the trade war are definitely ahead of us.

All of that bodes well for emerging markets, we believe. While it is impossible to forecast the future path of the US dollar, strengthening components are being taken off the table very gradually. At the same time markets are beginning to consider that the end of the Fed cycle will likely coincide with the start of the ECB hiking cycle. A weaker dollar is always the most significant positive in the markets for EM assets.

While dollar spreads are still about 120 basis points tighter than the wides of the "taper tantrum" era of 2013-2015, absolute dollar returns are negative by over 4%.

To appreciate how unusual that is, see the chart below. Over the past 23 years, EMD dollar returns have been negative only five times (including this year). That's unusual, but what is even more striking is that there has not been a major catalyst outside the asset class for the down year, as the chart shows.

Source: JPMorgan and Bloomberg; as of September 27, 2018. Data is the JPMorgan EMBI Global Index. Past performance is not a guarantee of future results. Actual results would vary.

Down years have historically been followed by up years. 2008's 12% fall turned into 2009's 30% rise. 2013's 5% fall was followed by 2014's 7.4% rise. That history should be of interest to investors even with the uncertain path for the rest of the hiking cycle.