Fixed Income

EMD Relative weekly notes: Week Ending May 29, 2020

James Barrineau

James Barrineau

Head of Global EMD Strategy

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2009 redux?

If you were an investor in 2008, just the configuration of those numbers probably evokes a physical reaction, given the emotional impact of what felt like a near-death experience in much of the financial sector. But the numbers “2009” evoke the remembrance of a furious rally that relentlessly left markets back at pre-crisis levels, if measured by spread in emerging market debt. In 2008, the sovereign index fell 12% while in 2009 it soared 29.8%.

Can this episode pull off that type of comeback? Our answer would be probably not, but there are enough positive aspects to the policy response to suggest a still-robust environment for returns.

If you look from the correct angle, there are similarities. Figure 1 shows spreads prior to both episodes, and then for a year following the financial crisis and the still evolving four months from the start of the pandemic market effects. 

Figure 1


Source: Bloomberg. The chart above depicts spreads-to-US treasuries for the JPMorgan EMBI Global Diversified Index for the period of September 8, 2008 through September 9, 2009, and January 21, 2020 through May 29, 2020. There is no guarantee that historical trends will continue.

Very similarly spreads hit a peak, retreated quickly, and then crept in at a much more measured pace for a considerable period of time. So far, so good.

But the financial crisis peaks were much higher, and the starting spread level was higher, and the spread peak came suddenly, while the COVID-19 peak reflects a growing realization of the damage. Nevertheless, the shape of the curves once the market regained its bearings has been remarkably similar – that’s encouraging.

For the GFC, the overwhelming policy response fiscally and monetarily could be measured for its efficacy fairly easily as areas of the financial system healed. This time, the trajectory of healing, while enormously helped by the policy response, could be affected by political decisions outside the realm of either forecasting or quantifying. So we would expect spread compression to eventually become more responsive to those factors than already implemented policy.

But that is not to say that spreads will not tighten. One new outcome of the policy response this time is to drive investment grade developed debt to new lows as well as official rates to what looks like semi-permanent zero levels. Without a major policy mistake, eventually the reach for yield should work its magic and lead to further spread tightening. 

In eight months, if  we mirrored the 2009 experience, spreads would have tightened about another 200 basis points. It might not be near 30% absolute returns, but still a compelling reason to stay engaged in the asset class, even if we fall a bit short of that due to the special nature of COVID-19.

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.