Fixed Income

EMD Relative weekly notes

Week Ending June 17, 2016


James Barrineau

James Barrineau

Head of Emerging Markets Debt Relative

In front of an event that will occur on a certain date, with a completely uncertain outcome and ambiguous effects afterwards, one would expect markets to err on the side of caution—and that seems to be the story with next week's Brexit vote.  A Bank of America fund manager survey released this week showed portfolio cash levels at their highest since November 2001.  

We couple that observation of market caution with our struggle to conclude that there will be lasting negative effects on emerging markets on a "leave" vote and therefore determine that there is little to do in terms of adjusting our views on the asset class on any time horizon that extends past next week.  Even in the event of a leave vote, we believe that the two-year timeframe for departure, at a minimum, makes other market factors more germane, and it is quite likely that a shift of risk in front of the vote will be seen as myopic in hindsight--or simply guessing at an outcome.

Once past the Brexit issue, markets are in our view more likely to focus on a period with a positive outlook for developed market central bank support.  The chart below shows yields on the US two-year bond this year near their lows which bodes well for a soft-to-stable US dollar. For emerging markets, we believe that suggests a good environment for local currency investing to potentially generate positive performance and for dollar yields—which have risen 15 basis points pre-Brexit—to re-trace that upward move eventually.  The asset class continues to improve fundamentally, with key countries like Russia and Indonesia the latest to cut interest rates while their currencies remained stable to higher in value—a telling indicator that markets appear comfortable with the policy framework and the overall liquidity environment.

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.