Fixed Income

EMD Relative weekly notes

Week Ending March 10, 2017


James Barrineau

James Barrineau

Head of Emerging Markets Debt Relative

The only plausible overarching explanation for market moves this week seemed to be a gathering fear that the Fed would be increasingly hawkish--even after a near-certain hike next week. Risk assets paused and the US dollar rose throughout the week, but peaked on Thursday--when the ECB surprised no one by continuing a dovish monetary policy with only tangential tweaks. On Friday, despite a US jobs number which exceeded expectations the dollar fell enough to more than compensate for the prior four day's rise. In response, risk assets rallied following the number. It seems clear that fears of an even bigger number were in play, and then disappointed.

This has implications for the dollar which, in turn, will affect emerging market assets. Despite what will clearly be a growing interest rate differential with other major developed economies, and despite a series of elections in Europe which are evoking cautious comments on their potential fallout, the DXY Dollar Index is still about 2% below its December peak. Its failure to strengthen further, despite those facts, to us seems a real positive factor for emerging markets.
To illustrate the power of the dollar, in 2015 the DXY appreciated over 7% and EM local currency had its worst one-year performance in the history of the JP Morgan GBI-EM Index. In 2016, there was a further 3.3% appreciation and the local currency index returned over 9%. But last year was misleading in that nearly all of that appreciation took place post the US election after depreciating from January onwards.

Fundamentally, a strengthening dollar takes liquidity from emerging markets, leading to lower foreign exchange reserves, weaker currencies, and eventually higher interest rates.

In 2016 EM countries were in the very first stages of unwinding that negative cycle, and a stable dollar in 2017 is allowing that unwinding to by and large continue. Asset prices and flows have followed, as retail flows from the beginning of 2017 through this week have been the largest in history (Source: EPFR). Therefore, if the dollar continues to have trouble breaking out of its tight range despite market acceptance of a more hawkish Fed, we think it‘s an unambiguous positive for emerging market debt.

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.