Fixed Income

EMD Relative weekly notes

Week Ending March 1, 2019


James Barrineau

James Barrineau

Head of Emerging Markets Debt Relative

EMD 2019: Act 2: The Carry Interlude

Act 1 was EXCITING, generating a 4.42% EMD dollar bond return in January and tacking on another 0.62% in February. Though our investing minds are taught to think in yearly terms, the prequel was pretty satisfying as well with a 1.46% return in December.1

As we all know, the action is unlikely to continue at that pace. Looking forward then, the likeliest outcomes will either be a re-tracement that leaves investors worse off from here, or a relatively stable, range-bound period without much in the way of fireworks but generating more positive returns than most of global income thanks to still higher yields:  the carry interlude. Macro factors suggest to us that the latter is the likeliest outcome.

We believe the factors that added sizzle to Act 1 are still in place, with the starring role being played by a Fed that has defined the top of the risk-free rate in a very narrow range. That allowed investors to calculate with more confidence where attractive rates were available and much of EMD, particularly non-investment grade EMD, moved into the spotlight. Co-starring was the peak of US growth receding further in the rear view mirror, which moved relative US growth closer to rest of world while removing a support beam for a stronger USD.

With those two factors still in play but with a more compressed spread structure relative to US treasuries for EMD, the stage seems set for stable, unexciting carry. Simply receiving the index yield for the rest of the year could give investors an additional 5% return potential for this year, in a hypothetical context. Given that most asset classes sang from the same sheet music as EMD to start the year, that seems likely to wind up being an attractive return going forward.

What could bring Act 2 to an end? A rise in inflation or stronger US growth that leads to a dollar revival would almost certainly do it. If you believe either of those is a probable outcome then you should most certainly not buy a ticket for what is coming. However, don't discount the possibility that Act 2 could end with a bang, perhaps after being extended for quite some time, with a meaningfully weaker dollar, if US growth is seen to falter and rate cuts loom off-stage. In that case, you won't want to miss Act 3: A Trip To Historically Tight Spreads.


1 Source: JPMorgan. The returns cited are cumulative monthly values for the JPM EMBI Global Index as of January 2019, February 2019 and December 2018. Performance shown reflects past performance, which is no guarantee of future results. Actual results will differ from index results.

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.