Fixed Income

EMD Relative weekly notes: Week Ending December 14, 2018

Week Ending December 14, 2018

12/17/2018

James Barrineau

James Barrineau

Head of Emerging Markets Debt Relative

If market pricing is anywhere close to being correct, next week the Fed will memorialize the fact that the risk-free rate is nearing its terminal point for this hiking cycle—and perhaps it will actually be at that point following next week's meeting.

For bond investors everywhere, but particularly those considering investing in EMD as the calendar turns towards the new year, that is a critical juncture.

It is not too early to consider the key question of how to lock in yields that in the future, with a stable to lower risk free rate, will look very attractive, in our opinion.

For EMD investors the decision should be made easier by the fact that yields on an absolute basis are now the highest they have been in nine years and three months to the day (Figure 1). For a mostly investment grade asset class, in the present set of economic and market circumstances that is compelling.

Source: Bloomberg, as of December 14, 2018. JPGCBLYD is the JPMorgan EMBI Global Diversified Blended Yield. Past performance is not a guarantee of future results. Actual results would vary.

What can go wrong? The Fed might not be close to the end, a reasonable assumption but one now at a large variance to market pricing. The US economy is unambiguously slowing, with the question simply being how far and how fast. So timing the end of the Fed hiking cycle might be difficult, but we feel the direction of travel towards wrapping it up seems like a high probability bet.

What could go particularly right? Were one to sell US high yield bonds, they would swap an asset highly correlated to US equities for one less correlated, and one that has under-performed against HY by nearly 5% this year. Should the end of the hiking cycle bring a stable-to-softer dollar, then non-US assets like EMD would be a prime beneficiary and we believe returns have the potential to exceed the near 6-7% yields now currently available on the index.

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.