Fixed Income

EMD Relative weekly notes

Week Ending January 20, 2017


James Barrineau

James Barrineau

Head of Emerging Markets Debt Relative

With a new administration finally in place, policy uncertainty on key market issues will fade gradually and we will discover whether the "reflation" trade pricing in higher growth, or a less robust outlook dominated by a protectionist bent, will drive asset prices. The US dollar (see chart below) for the period just preceding the presidential election to today sums up that tension, as the reflation-driven spike in the dollar has gently faded totally in concert with bond market dynamics.

Source: Bloomberg, DXY US Dollar Index; data as of January 20, 2017. Past performance is no guarantee of future returns.

We don't know how the policy mix will fall out, nor do we know how the market will react to its exact shading, and we certainly cannot invest on a blind guess in either direction. What we can do, however, is to interpret that the current signs for emerging markets suggest this asset class is approaching the near-term future from a position of strength.

• Retail flows into the asset class continue, although the pace of inflows dropped off this week. The change in foreign exchange reserves, a more important liquidity signal for us, has turned more positive over the past few weeks. Of those countries reporting weekly, Colombia, Brazil, Argentina, Mexico and Russia were positive in the most recent data.

• Debt issuance this week topped $15B on Wednesday alone, followed by $7B from Argentina on Thursday. That type of market digestion of new issues suggests refinancing risk is not an issue in the market for all but the most distressed corporate issuers.

• As we saw last year, a stable dollar is essentially all that is necessary for local currency EM debt to perform well. If that dynamic is maintained, central banks across emerging markets will have a stable framework within which to manage interest rates. History shows that downside growth risks have the potential to dissipate when that is the case.
Given these factors we see no reason to believe that emerging markets would suffer disproportionately as compared to other asset classes should markets object to future policy pronouncements. Cabinet confirmation hearings this week suggest that while trade policy will certainly change, it is unlikely to do so in a reckless manner. In our view, that provides additional comfort that the market's current pricing of anticipated policy shifts as far as EM is concerned is likely not too far off base.

The views and opinions contained herein are those of Schroders’ investment teams and/or Economics Group, and do not necessarily represent Schroder Investment Management North America Inc.’s house views. These views are subject to change. This information is intended to be for information purposes only and it is not intended as promotional material in any respect.