Fixed Income

EMD Relative weekly notes

Week Ending May 5, 2017

05/10/2017

James Barrineau

James Barrineau

Head of Emerging Markets Debt Relative

The first round of the French election, with its positive outcome from a markets perspective, resulted in an immediate 50 basis point drop in the US dollar index. In the subsequent two weeks of trading we have had an ECB meeting and a Fed meeting, and the dollar has continued to trade in the same tight range established after the French outcome. Until something changes in the drivers for the dollar, we feel that portends a stable environment for emerging markets, broadly.

The market emerged from the Fed meeting this week with a 94% probability of a June hike so it is difficult to see a near-term environment change that would upset the outlook. In April, the 30-year treasury bond took a round trip from 3% yields to near 2.85% and back again--another signal of relative stability. Lastly, the VIX fell below 10 on Monday for only the ninth time since 1990.

In our view, that makes this an ideal environment for carry – the income producing device that bond investors employ when they remain invested in a relatively robust yielding asset class. And that is exactly the advantage that emerging markets currently enjoys within global fixed income.

In this environment one can attempt to heroically predict a resumption of volatility and begin to raise cash but, as suggested above, the evidence that “now is the time” is pretty thin and the cost for doing so is foregone high current income. So, not much happening in global markets remains a very positive backdrop for our asset class.

An exception within the asset class remains Venezuela. The chart below shows the drop in Venezuelan reserves, and the bulk of those may not be readily accessible and in the form of physical gold. The political environment continues to deteriorate, with nearly daily negative news. Venezuelan bonds maturing in December 2018 have fallen four points in the last five weeks but still trade at a 69 dollar price. We continue to believe the level of complacency is completely unwarranted. A Venezuelan default, when it arrives, will possibly produce the following effects: a questioning of the fiscal health of other lower-rated EM oil producers (which to our mind would be more of a buying opportunity), a potential jump in oil prices as the Venezuelan oil company deals with a disorderly, temporary legal battle over assets and the ability to export oil, and in the words of Warren Buffet, this will represent for EM providers “the tide going” out that will reveal who has maintained a measure of risk discipline rather than yield chasing in their willingness to put client capital at risk in the country.

 

Source: Banco Central de Venezuela (BCV), Haver Analytics; data as of May 5, 2017  

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.