Fixed Income

EMD Relative weekly notes

Week Ending August 17, 2018

08/17/2018

James Barrineau

James Barrineau

Head of Emerging Markets Debt Relative

Our storylines on where we are in the Emerging Markets historical cycle

1. Strong dollar = Sell EM

Check! USD is up over 7.5% since April 16 while EM dollar sovereign index is down 4.9% and local currency EM is down 9.5% year to date.

2. Strong dollar creates EM/international cracks = Sell EM

Check! EM countries with the largest external financing needs, mostly measured by current account deficits, have come under market pressure. Turkish dollar bonds are down over 15% and the currency is down over 25% year to date; Argentine dollar bonds are down over 16% and the currency is down 33% in 2018.

3. Policy responses fitfully address liquidity stress = Sell the last bits of EM

We are here! Argentina has received IMF funding and revamped monetary policy, reducing currency volatility. Turkey has raised costs to short the currency, secured some funding from Qatar, and promised further fiscal measures. Indonesia, while out of the center of the storm, has raised interest rates to slow growth and address market concerns proactively. Results are uncertain and markets struggle to balance better policy frameworks against terrible investor sentiment. In only the first two weeks of August, the dollar EM sovereign index has fallen 1.7% and the local currency index is down over 5%.

4. Tipping Point: A menu of Developed Market possibilities ease liquidity concerns = Buy EM

Should the international or EM stresses begin to affect the US fundamentally, the Fed could very well hint that its hiking cycle is winding down. This is what kicked off the very strong EM recovery from early 2016 through 2017. A slowdown in the US exacerbated by a too-strong dollar or a sharp equity correction for any reason could potentially do the same. Negative trade war effects impacting the US would likely have a similar result.

The distance from step 3 to step 4 is the great unknown, of course. The depth of August selling, however, logically increases the odds that markets have opened up a margin of safety for investors while we wait for that step to materialize—and that will only be apparent in hindsight.

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.