EMD Relative weekly notes: Week Ending June 14, 2019
The market has aggressively priced in Fed rate cuts that, at least for now, seem quite unlikely to start with the June meeting (less than a 23% probability, according to current market pricing). Some second thinking about how swiftly the market has moved towards lower US rates has become apparent this week: the US dollar has risen nearly 1% percent in the past week (re-tracing about half of its drop this month), and 30-year Treasuries have flattened in yield after the swift fall in May.
That has been reflected in emerging markets by a sharp rally in the most liquid, biggest part of the asset class: bonds rated BBB, which represents around 35% of the dollar market. Since the beginning of 2018, they have rallied far more than BB-rated sovereigns. This price movement also reflects the fact that as new investors enter the asset class this segment is the first stop for them—and for many (like global bond funds), the last stop. Consequently, the spread of BBB bonds to BB bonds is at an historical high, as shown in Figure 1.
Source: Bloomberg. Chart depicts the spreads-to-US Treasuries of the BBB-rated (JPBYGDBX) and BB-rated (JPBYGDBB) EMD sovereign bonds ending June 14, 2019.
We would be remiss if we did not suggest that this part of the asset class indeed looks rich and is vulnerable to further unwinding of market conviction on Fed rate cuts.
However, other parts of the opportunity set look much better. Corporate debt has lagged sovereigns by almost 200 basis points for investment grade, and 140 in non-investment grade. While emerging market returns year-to-date look gaudy with the sovereign dollar index up over 9%—in an environment when the risk free rate still looks likely to fall eventually this year—the less traveled roads in EMD still offer attractive opportunities to take advantage of the potential generous income on offer.
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.