Fixed Income

EMD Relative weekly notes: Week Ending November 8, 2019

James Barrineau

James Barrineau

Head of Emerging Markets Debt Relative

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Should a Treasury sell-off worry EMD investors?

Clearly, a sell-off in benchmark Treasury bonds captures the concern of a fixed income investor in any asset class, and this sell-off has occurred at lightning speed: the long bond has risen from 2.01% on October 4th to 2.40% as we write this. Less appreciated has been the global nature of the selloff. Ten-year German bunds have gone from -60bps to -26, while 10-year Japanese JGB bonds have gone from -25bps to -7bps.

On a macro basis, the sell-off seems to us to be a bit aggressive. The Atlanta Fed's GDP forecast for the fourth quarter in the US sits at 1%. Inflation expectations as measured by five-year yields expected five years forward sits comfortably under 2%. The potential end of the trade war might translate into better global growth going forward, but even a partial deal has yet to be completed. The market is currently pricing in less than a 9% chance of a rate cut in December, and just over a 50% chance of a single hike by the end of 2020, so Fed expectations have not shifted to support a deep yield retreat.

Nevertheless. nothing is certain in markets. If a fixed income investor is fearful of a further yield rise from here, two key considerations would be: 1) the correlation of their existing holdings with treasuries and; 2) the yield cushion contained within their holdings to compensate for the risk of further price falls predicated upon a global back-up in yields.

For EMD investors, we think both counts are comforting. The correlation of the hard currency sovereign EM dollar benchmark to an index of Treasuries is a small 0.18 (source: Bloomberg). Obviously, the EM yield advantage remains: the spread over equivalent treasuries is just over 320bps. Even the most highly correlated part of the EMD universe, single A bonds, returned only a negative 1% for the past month as Treasury yields soared.

In short, for investors worried about the potential for further back-ups in Treasuries and global developed markets as a primary risk, our view is EM should be one of the last parts of a diversified fixed income basket to trim.


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.