EMD Relative weekly notes: Week Ending October 11, 2019

The Illusion of Yield and Value

We must confess that the sovereign index yield of 5.17% as of this writing seems kind of skinny to anyone following emerging markets over a long period of time. But like everything else in global fixed income, one's frame of reference for value must evolve in a world where Greece can issue 13 week treasury bills at a yield of minus 2 basis points as they did this week.

In this brave new world of semi-permanent QE and the destruction of future income for as far as the eye can see, in emerging markets a more reliable way to gauge value is to look at historical spreads to US treasuries, especially in the context of global monetary cycles. Figure 1 helps to explain this.

Figure 1


Sources: Bloomberg, data as of October 11, 2019. Chart depicts 30-year US treasury yields and the spread over them by the JPMorgan EMBI Global Index. Performance shown reflects past performance, which is no guarantee of future results. The value of investments can go down as well as up and is not guaranteed.

The two large peaks in the dark blue spread line are, to the day, when the Fed explicitly turned to more permissive monetary policy. In 2016 this was delaying a hiking cycle for a year; in 2019 this was a shift from hiking to easing.  

We are now 10 months removed from the latest Fed shift, and it is clear that the current spread tightening can go further, absent shifts in the broad macro environment. The spread tightening ten months on was about 31% in 2016, whereas it is less than 20% today. However, yields are now identical, or nearly so.

If spreads begin to creep lower from here—and we believe a turn in the dollar would likely help induce this as it did in 2017—then absolute yields for the sovereign dollar index could well fall to just over 4%. 

In an historical context that seems an unlikely scenario to have an average EM sovereign bond trading at that yield level. In today's framework that could represent a fair income opportunity should we see that day arrive.


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.