Fixed Income

EMD Relative weekly notes: Week Ending March 29, 2019

04/01/2019

James Barrineau

James Barrineau

Head of Emerging Markets Debt Relative

How does emerging market debt perform in a market where US treasuries rally strongly? The answer is quite well, if history is any guide.

We ask that because many investors unfamiliar with the asset class often think of it as something set apart from global fixed income markets, driven by individual country developments in a multitude of different ways and full of unanticipated volatility lurking around every corner.

The truth is much more benign. EMD reacts like other fixed income asset classes across a broad swath of macroeconomic developments, with credit risk driven often idiosyncratically—just like global developed corporate and sovereign investing.

The key for EMD has been the identical key for the broader global markets of late:  the drop​ in growth and inflation expectations. Figure 1 shows the fall in the market's preferred indicator of inflation expectations, the five-year US Treasury bond five-year forward futures: Good for fixed income, period.

Figure 1

Source: Bloomberg. Chart depicts the USGG5Y5 Index through March 28, 2019. Performance shown reflects past performance, which is no guarantee of future results. Actual results will differ from index results.

Figure 2 shows how high-rated parts of EM—single A rated bonds—have done in response, coupled with US Treasuries. The high correlation is obvious, but also note the yield structure of the single As on the left axis—about 120 basis points above treasuries. The additional yield plus correlation to Treasuries makes this pocket of EMD an ideal hunting ground for investors as inflation expectations fall.

Figure 2

Source: Bloomberg. Chart depicts the JBBYCA Index (white line, LHS) and the GT30 Index (yellow line, RHS) for the period ending March 28, 2019. Performance shown reflects past performance, which is no guarantee of future results. Actual results will differ from index results.

About 52% of the sovereign index is investment grade, along with 60% of the corporate EMD universe. As highly rated Middle Eastern oil and gas producers enter the index that sovereign percentage is set to increase. Ongoing macro developments, if sustained, thus mean that over half of the dollar opportunity set for EMD investors are  currently higher yielding and well correlated to developed market bonds that should be considered as a way of investing in this dynamic.

 

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.