Fixed Income

EMD Relative weekly notes

Week Ending February 17, 2017

02/23/2017

James Barrineau

James Barrineau

Head of Emerging Markets Debt Relative

Like other asset classes, emerging market debt wobbled slightly this week after a very strong start to the year. Even so, sovereign index yields went up a meager three basis points for the week, and retail fund flows into the asset class remained positive. If a disappointment in prospects for additional growth stimulus becomes the theme in markets, emerging markets should in a position to perform relatively well in the short term, we believe.

A key reason for our belief is that the two assets most aligned with EMD returns have already retraced from post-US election highs in anticipation that additional stimulus might disappoint. Thirty-year treasuries, whose yield jumped from 2.6% before the election to peak at 3.18% in December, now stand at 3.02%. The dollar index similarly soared from just over 97 to over 103 but now stands at under 101. So it’s hard to imagine further disappointments sinking those markets disproportionately.

Of course, the same can hardly be said about global equities.

Because this potential disappointment comes when actual inflation in developed countries is rising and growth prospects even without additional stimulus seem robust, it’s difficult as always to project the future. However, should equities also re-trace gains like other markets have, it could lead to a lower US dollar which has reliably been an historical positive for emerging markets. Similarly, lower yields globally, even if spreads widen modestly, would lead to dollar EMD assets performing well, in our view. So even with this week's slight wobble, a high level of concern seems premature given what we know today.

Fundamentally, emerging market inflation is to some degree converging with developed market inflation as currency stability over an extended period has greatly aided central banks in developing countries. Growth prospects in key countries are still robust, though very modestly lower growth is possible in places like India and parts of Asia. Emerging markets, therefore, seem well positioned for some pick up in asset price volatility should the movements of this week prove to be a precursor.

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.