Fixed Income

EMD Relative weekly notes: Week Ending June 21, 2019


James Barrineau

James Barrineau

Head of Emerging Markets Debt Relative

EMD is a huge beneficiary of the events of this week that have left most asset markets in a “risk-on” mode. The EMD perspective should be seen within the context of at least a partial return to the decade-long QE practice by the majority of developed market central banks:

  • Both the Fed and the ECB validated what had already been occurring—a realization that global growth could not support any type of return to interest rate "normality."​ The stock of debt with negative yields has essentially doubled since November as shown in white in Figure 1, correlated with the move downward in US treasuries. That means the hunt for yield is on, and EMD is a prime beneficiary.

Figure 1


Source: Bloomberg. Chart depicts the market value of negative-yielding debt within the Barclay’s Global Aggregate Index (BNYDMVU) as well as the USGG2YR and USGG30YR indexes ending June 21, 2019.

  • It is striking that Mario Draghi delivered a surprise dovish message a day prior to the Fed, and EM local currencies rallied. That is significantly signaling that DM easing is driving capital into higher-yielding local debt, rather than a focus on fears of a stronger dollar.
  • The combination of the ECB’s and Fed's messages has left the USD weaker. This suggests that markets are focused on where rates can fall faster—the US—rather than those with a more limited and less straightforward selection of easing options.

There are few areas of EMD that we believe will not benefit from the aggregate impact of the developments noted above. High grade debt will benefit from the overall compression of yields, though this has definitely been aggressively anticipated by markets. These developments come when the credit curve in EM—the difference between investment grade and non-investment grade—was nearly as high as at peak stress of 2016. This suggests non-investment grade EMD is likely to out-perform. Lastly, in local currency a weaker dollar historically means out-performance. A number of countries have started or are likely to start rate cutting cycles themselves—Russia, Indonesia, Brazil, Mexico, South Africa—and this should boost growth, enhance creditworthiness, and enhance local rates returns—underscoring the virtuous cycle that comes as liquidity shifts from DM to EM.

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.