EMD Relative weekly notes: Week Ending September 13, 2019
ECB delivers for EMD
We like to say that there are two aspects of market event risk that make forecasting a foolish enterprise: 1) forecasting which way the event will break, and 2) forecasting the market's reaction to the event. For the ECB meeting this week, the outcome was probably within the zip code of reasonable expectations, with a dovish tilt and a long-fused commitment to QE to boot. However the Euro did not follow script—falling quickly but then rising steadily—and that outcome, should it continue, bodes well for emerging market debt.
Delivering a dovish result and having the currency rise (at least through this writing) has engendered differing explanations. Whatever the cause, as long as the Euro does not fall significantly after a likely final easing push, the explanation matters less than its positive impact on flows into EM.
EM debt results had flatlined in August, with the local currency index falling 2.6% and dollar debt essentially flat as the DXY dollar index approached levels last seen near the peak of early 2016 (see Figure 1). Even before the ECB a somewhat softer dollar from that peak had already helped sentiment, with bellweather currencies like the Mexico peso and South Africa rand up around 3% in the first two weeks of September.
Source: Bloomberg. Chart depicts DXY (US Dollar Index). Data as of September 13, 2019. 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.
If the market believes monetary policy differentials can only narrow from here as the Fed cuts, dollar strength probabilities wane and our view is that EM sentiment will then likely improve.