Fixed Income

EMD Relative weekly notes

Week Ending February 10, 2017


James Barrineau

James Barrineau

Head of Emerging Markets Debt Relative

The market environment for EMD in our opinion remains quite favorable from the perspectives of both fundamentals and liquidity.

Total retail fund flows rose $2.5B this week, the strongest week of the year.  ETF flows are up nearly $1B year to date.  A blended return for the three main indices in EMD (consisting of the JP Morgan GBI-EM Global Diversified Index, the JP Morgan EMBI Global Diversified Index and the JP Morgan CEMBI Broad Diversified Index) is up 2.6% as of this writing.

But a more significant liquidity indicator is also up.  The chart below shows the aggregate level of foreign exchange reserves for all EM countries that report them on a weekly basis.  It's easy to see the sharp drop in reserves following the US election, but it is equally easy to see the ongoing rebound from this low point in January.

Source: Bloomberg, data from Argentina, Brazil, Chile, Colombia, India, Mexico, Peru, Russia, Thailand, Turkey as of February 10, 2017.

What is most encouraging about the growth in reserves is that fundamental improvement generally follows these flows. With reserves growing and currency levels stable to appreciating, central banks have considerable degrees of freedom to administer optimal policies.  Rate cutting cycles are underway in Brazil, Colombia (albeit haltingly), and Argentina and probably will be soon to start in Russia.  Should currencies continue to stabilize we would expect stressed countries like Turkey and Mexico to be able to loosen monetary policy later this year as well.

The pass-through from previous currency depreciation to inflation is falling demonstrably in these and other countries. Growth is rebounding where it was previously in recession (Argentina, Brazil, and Russia) and stable to slightly improving in most of the rest of the asset class.  An extended period of reserve growth should continue to fuel this trend.

This week was notable in that the DXY dollar index rose modestly, and is now up 1.3% for the month.  Despite this the EM local currency index is up just over 1% for the month.  It is encouraging that the fundamental improvements so clearly recognized by the market are leading investors to conclude that continued exposures are warranted despite the strengthening dollar.  If the dollar's run stabilizes or reverses--and the Trump administration continued to talk down the dollar this week—we believe EM asset prices should continue to be buoyant given the improving backdrop.

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.