EMD Relative weekly notes
Week Ending May 31, 2019
One of our enduring themes is that investors should think of emerging market debt like any other mainstream fixed income asset class. As such, parts of EMD offer the potential to produce positive results for investors in response to specific macro drivers—just like any other diversified fixed income allocation.
Of late, that driver has been growth fears sparked by the presumably now-entrenched trade war theme. In response, investment grade EM Sovereign Debt Index is up about 7.9% this year and nearly a full percent this month. Similarly-rated corporate debt, an index with less duration, is up 6.4% and over 80 basis points, over the same time periods. Meanwhile, US investment grade debt, as measured by the Barclays Corporate Bond Index, is up 6.5%—so investors in IG EMD have handily kept pace with what is considered a significantly less risky sub-sector.
Non-investment grade EMD has fared less well but has still benefited as bonds have rallied globally, with EMD sovereign up 6.4% and EMD corporate up 6.3%, respectively.
As investors more aggressively price in a Fed easing cycle and growth forecasts for the US continue to fade—the Atlanta Fed has Q2 growth at 1.2% currently—it is difficult to envision investment grade debt selling off significantly in any fixed income area, including EM. If that supposition is correct, then non-investment grade EM debt is historically inexpensive. Figure 1 shows the spread difference between single B and BBB rated bonds in EM. The current spread is whisker below the near-term peak of late 2018.
Source: Bloomberg. Chart depicts the yield spread between B-rated and BBB-rated sovereign issues within the JPMorgan EMBI Global Index for the 12 months ending May 31, 2019.
What is different now is that the previous peak was caused by negative EM sentiment coupled with a US equity sell-off. The current peak can be explained by the overwhelming macro driver of slower growth expectations. If those expectations play out, we think the much higher current yields available in non-investment grade EM will eventually look quite attractive relative to the rest of global fixed income, despite its own good performance year to date.
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.