Fixed Income

EMD Relative weekly notes: Week Ending August 2, 2019

James Barrineau

James Barrineau

Head of Emerging Markets Debt Relative

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After the Fed meeting this week, markets were somewhat disappointed at signs that the first interest rate cut in 11 years would not be the start of a steady rate cutting cycle.​ That was quickly followed by a surprise boost to US tariffs on Chinese imports which constituted an even clearer blow to market bullishness. Now, much of the market believes the following formula: More tariffs=slower growth prospects=more rate cuts=...

What comes next is what likely determines second half returns not just for emerging market debt but for capital markets in general. If the (nearly unquantifiable, but certainly negative) trade war damages growth just enough, it is entirely possible that a more aggressive rate cutting cycle leads to optimism that keeps assets in their current “still-elevated” state. If the additional tariffs become the tipping point for entry into a global recession, then widening credit spreads and weaker equity prospects may overwhelm a rate cutting cycle and become a self-fulfilling part of the downturn. No one knows which road lies ahead.

For emerging markets the uncertainty surrounding that question could be ameliorated if a falling US dollar—spurring inflows into EM—were to accompany the growth slowdown and rate cut anticipation. While we would like nothing better than to suggest with certainty that is likely, it has not happened yet.  

Figure 1 shows the path of the dollar in 2019—marching higher despite the market steadily shifting from rate hike to rate cut anticipation. Much of that can be attributable to the more negative outlook for other developed economies, particularly Europe and the UK. With growth slowing but still positive in the US it has still looked like the better bet with a significantly higher rates structure.

Figure 1


Source: Bloomberg. Chart depicts the DXY index for the period ending August 2, 2019. Past performance is no guarantee of future results.

Ironically, the more aggressive steps in the trade war might change that relative calculus and leave the dollar weaker with capital flows trending from US to emerging markets. That would leave the asset class in a relatively privileged place compared to US assets, but the "fog of war" until we learn whether that thesis is correct would still foretell a bumpy ride.


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.