EMD Relative weekly notes: Week Ending March 27, 2020
In EM, only the strong (mostly) will survive
We believe two things are true: 1) this is a rare, once-in-a-decade opportunity to buy emerging market debt; and 2) the virus fallout will leave global developed market growth prospects in the medium-term weaker, and weaker EM credits will be particularly vulnerable to the fallout. These are not mutually exclusive.
Figure 1 shows the spread of sovereign dollar debt zooming to global financial crisis levels. Unless the historical trends of the asset class are about to be re-written, it will not stay there and when it falls, it will do so dramatically.
Figure 1: EMBI spreads since the global financial crisis
Source: Bloomberg. The chart depicts the spreads to US treasuries of the JPMorgan EMBI Global Diversified Index from January 1, 2008 through March 25, 2020. There is no guarantee that historical trends will continue.
The Fed has begun to gain traction in alleviating the global dollar squeeze and emerging markets were perhaps hurt most by that. The easing of that pressure will help to drive spreads tighter in the near term, along with better risk sentiment from massive fiscal stimulus.
Over the course of the next few quarters and in the years of post-virus recovery, however, we believe there are ample reasons for global growth to remain sluggish. Much more heavily indebted actors – from consumers to sovereigns – are a recipe for slower growth. Although emerging markets have not had the scope to stimulate to the same extent as developed markets they also are held more accountable by markets for higher debt levels.
All this means that weaker sovereigns, and weaker corporates in emerging markets, are likely to bounce in price along with everything else but reach a ceiling – as at a certain level of price recovery a more sober analysis of forward prospects may take place. Sustainable price recovery is much more likely for investment grade EM than lower rated non-investment grade EM.
Investors must also consider that central banks in the developed world are quite likely to be locked into QE for a long, long time. Income opportunities for future investment – which we thought looked scarce a few months ago in DM – could be compressed into near-nothingness.
Investment grade EM and local rates in EM should be sustainable landing spots for investors seeking to lock in income in a world that could produce very little of it.
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.