EMD Relative weekly notes: Week Ending January 17, 2020
EM FX Volatility: Dead Zone
Volatility in emerging market currencies is dead. Deceased, departed, passed away.
The chart below shows the evolution. It is at an all-time low, following in the footsteps of developed currencies, and represents an offshoot of low, but stable economic growth. We feel it also indicates the market’s belief that central banks that are likely not going to be moving policy in a foreseeable time horizon.
Source: Bloomberg; data January 2, 2014 through January 15, 2020. Chart displays the 30-day trailing volatility of the JPMorgan GBI-EM Local Currency Index. Performance shown reflects past performance, which is no guarantee of future results. The value of investments can go down as well as up and is not guaranteed.
You might think that taking advantage of this (potentially ephemeral) phenomenon is a simple function of buying the index—after all the index currently yields 5.16%—and that represents a fine return compared to developed market rates.
But that would be wrong, in our view.
In 2019, your return on rates for EM index countries was 12.34% and your FX return was a skimpy 1.13%. This rates rally, while broad-based, was widely dispersed and leaves probable returns widely dispersed. In Thailand, for instance, the rates return last year was nearly 11%, yet current rates stand at an index level of 1.61%—not very attractive, even if FX volatility is scant. Central European rates are broadly sub-2% now, and that cohort constitutes about 20% of the index.
Where the action is are those countries with still-positive real rates, and nominal rates that represent a significant pick-up to developed markets. Russia, Mexico, and Indonesia have started the year with strong currency appreciation as investors have begun to pick up on this. Brazil, where real rates have been slashed and nominal rates at 6% are only moderately attractive, has struggled as has much of the asset class. Turkey has outperformed but only after a period of some weakness and South Africa has paused after a very strong fourth quarter.
Lower currency volatility will feed into fundamental improvements broadly—more stable interest rates, more predictable monetary policy, and better growth prospects with more stable capital flows. But market return prospects, in our view, are unlikely to be so broadly beneficial for investors going forward.
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.