Economics

EMD Relative weekly notes: Week Ending October 4, 2019

09/10/2019

James Barrineau

James Barrineau

Head of Emerging Markets Debt Relative

The Turn (?)

2019 continues to look an awful lot like 2016 for EMD investors: a Fed changing the rates path to less hawkish and cooperative global macro conditions for fixed income that lead to robust gains—in the case of 2016 about 10% across broad sub-sectors and this year slightly better on the dollar side thanks to aggressively falling global yields. The returns in both years happened in spite of, not because of, the USD. In both years the dollar was up 2-3%, thus soaking up global capital flows from the rest of the world and EM in particular.

In 2017, however, the dollar fell sharply from peak to trough about 12.7%—and this put rocket fuel into EM assets despite the previous year rally, as dollar EM rose roughly another 10%— with local currency shooting forward 15%. So it doesn't take much insight to conclude that going forward from here the dollar must be cooperative for continued EMD gains rather than simply relying on global yield declines. 

Figure 1

EMD-Weekly-Notes-10.9.2019-v1.jpg

Sources: Bloomberg, data as of October 4, 2019. Chart depicts the Citibank Economic Surprise Index and the DXY Index. Performance shown reflects past performance, which is no guarantee of future results. The value of investments can go down as well as up and is not guaranteed.

The Citi Economic Surprise Index (dark line) measures data versus expectations, and as the market shifted from believing in a coming recession to thinking growth would be moderate, data has consistently exceeded expectations—so much so that the index reached multi-year highs recently. However, it is indisputable that narrative is turning.

Generally, the very strong dollar has marched in lock-step with the Citi index. With the recent turn the dollar, too, has softened—from a high not seen since mid-2017 to slightly lower levels.

Of course we cannot know what the future holds, but the data is suggesting to us, the necessary turn for EMD investors could be at hand.