Fixed Income

EMD Relative weekly notes

Week Ending June 22, 2018

06/26/2018

James Barrineau

James Barrineau

Head of Emerging Markets Debt Relative

The underperformance of emerging market debt (“EMD”), as measured by the JPM EMBI Global Index, to other asset classes year-to-date has been stark:

– Relative to the BAML US High Yield Index EMD has underperformed by about 550 basis points
– Against BAML US Investment Grade Index it has underperformed by about 280 basis points
– Against US treasuries it has underperformed by about 420 basis points
– Against the S&P 500 Index it has underperformed by about 800 basis points

In our view, the poor performance has not been related to risk appetite in general and has been very specific to the asset class. But it is also safe to say that this particular cycle has unfolded with unusual swiftness, even relative to the history of emerging markets. In this case we have a recent comparable scenario: the fall of emerging markets from mid-2014 to January 2016 caused by a rapid ascent in the USD, similar to today.

The lows in spread-to-US treasuries for the JPM EMBI Global Index for both periods are nearly identical: 261 basis points this past February 2nd, and 258 basis points on June 11, 2014. The widening to our current level of about 370 occurred over about 15 weeks. From the low in 2014 the widening through 15 weeks was only to 322. So through similar timeframes, the current episode has seen an increase of more than 150% (109 basis points versus 64 basis points) of spread widening compared to the sharp dollar rise episode of 2014.

The 2014 period saw an 8% rise in the dollar; this time, so far, it has been 6.9%. That comparison suggests to us that the current sell-off has been more extreme despite a slightly less forceful negative catalyst. While we can't forecast the future, this recent trend leads us to believe the market may have priced in a significant amount of bad news in EM dollar bonds relative to historical catalysts in a very compressed period—which should be a heartening thought for investors trying to dimension future return prospects, especially with an index yield over 6.5% for sovereign EM 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.