Fixed Income

EMD Relative weekly notes: Week Ending November 30, 2018


James Barrineau

James Barrineau

Head of Emerging Markets Debt Relative

When markets come to inflection points in terms of investor sentiments or changes in significant asset price drivers, it is not uncommon for traditional, historically reliable relationships to break down temporarily. For emerging market debt, the month of November was a significant outlier in many ways.

– The dive in the price of oil soured sentiment, though fundamentally around half of the EM asset class benefits from lower oil.
– The correlation between currencies and dollar spreads to US treasuries cracked, with the local bond index up over 2%, while dollar bond yields rose 39 basis points—there is an historic 80% correlation between movements in the two indices.
– The very tight historical correlation between the dollar and local currency broke down, with the dollar up about 1% for the month, which would traditionally lead to lower, not higher, EM FX returns.
– Most importantly, the market's stronger belief that the end of restrictive monetary policy is near should lead to robust EM return prospects, if history is any guide. Figure 1 shows plunging probabilities for 2019 rate hikes, which did nothing at all to turn EM sentiment around (at least so far).

Source: Bloomberg, as of November 28, 2018. Data is derived from Fed Funds futures contracts. Past performance is not a guarantee of future results. Actual results would vary.

With other asset classes like US equities stressed, short-term outcomes like these should not surprise. But market outcomes outside of broad norms are, by definition, temporary. US growth is slowing, market expectations for future restrictive policies are fading, and those are key ingredients for re-asserting the relationship of a softer dollar and, in our view, the potential for strong EM returns.

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.