Fixed Income

EMD Relative weekly notes

Week Ending October 12, 2018

10/12/2018

James Barrineau

James Barrineau

Head of Emerging Markets Debt Relative

Always and everywhere, a consistent tightening of financial conditions will eventually lead to stress in asset prices. It is painful to anticipate this too soon, painful to believe it won't happen, and painful to read all the articles that explain with perfect hindsight why it was inevitable when it finally manifests.

Emerging markets were early in experiencing this and investors should mark a sharp differentiation between emerging and developed markets now.

Figure 1 shows a basket of EM country default swap prices—a measure of perceived default risk—as a stress indicator coupled with the US VIX equity volatility indicator. This chart makes clear that EM has already been feeling the heat months before the US.

 

Source: Bloomberg; as of October 11, 2018. Data is the Emerging Market CDS Index and the VIX Index. Past performance is not a guarantee of future results. Actual results would vary.

As we move forward, we feel the potential market responses are likely to be very different. The US equity sell-off has caused treasury bond yields to at least pause in their rise, and it has helped the dollar to soften as shown in Figure 2 on a one-month basis.

Source: Bloomberg; as of October 11, 2018. Data is the DXY Dollar Index (LHS) and the UST 30-year yield (RHS). Past performance is not a guarantee of future results. Actual results would vary.

Both of those things are unmitigated positives for EM.

To the extent that risk fears remain rampant in the US, it will naturally lead to speculation about the Fed more definitively signaling the end of its hiking cycle, and that view should lead to a continuation of the two trends discussed above, in our opinion. 

It should be apparent to prospective investors in EM that these factors make EM risk much, much different than that which has been experienced in US equities this week.

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.