Fixed Income

EMD Relative weekly notes

Week Ending September 22, 2017

09/29/2017

James Barrineau

James Barrineau

Head of Emerging Markets Debt Relative

It’s clear from history that an appreciating USD has been negative for emerging markets, and a depreciating US currency positive. The current depreciation trend has clearly boosted asset prices and currencies across the EMD asset class. So this week's Fed meeting should cause EMD investors to ask: did the meeting do anything to turn the trend around? Preliminary evidence in our opinion says no.

The chart below is exhibit A. It shows the DXY US Dollar index immediately prior to the Fed meeting through this Friday morning, and shows the spike up in the dollar post-statement has apparently not been taken by the market as a harbinger of structural trend, as the move was largely reversed. EM currencies fell over both Wednesday and in Latin America on Thursday, but rose almost universally on Friday.

Source: Bloomberg, DXY US Dollar Index, data as of September 22, 2017. Performance shown reflects past performance which is no guarantee of future results.

As always, we encourage investors to focus on primary drivers, rather than arbitrary asset price levels or past returns--either of which we believe are highly likely to result in sub-optimal results if used as a guide. The soft dollar trend remaining intact, as long as it lasts, should result in local currency being the best sub-sector, while also dragging dollar credit risk along at a slower pace given historically high correlations.

What comes after this week is predicated on both observable economic data and less transparent political maneuverings, making this a more unusual period for watching the Fed and its implications for our asset class. Of course inflation numbers will likely drive December rate hike probabilities, but if the ECB decides to more firmly state it's QE withdrawal policy the dollar might not rally regardless. That is probably not a forecastable matrix of events and market reactions to them.

The number of current Fed vacancies and the eventual choice of a new chair person makes analysis of what the Fed forecast "dots" show nearly useless. Many suspect that President Trump will appoint a chair more based in markets rather than academia, which the market further suspects would result in a more dovish Fed. If that is the case, then selling EMD this week will turn out to have been a large mistake, if history is any guide.

We remain open to evidence that would overturn our current EMD investment thesis, which is that we are in a weak dollar, ample EM liquidity environment that should benefit EMD asset prices broadly. This past week did not give us any evidence worthy of over-turning that thesis.

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.