Fixed Income

EMD Relative weekly notes

Week Ending March 3, 2017


James Barrineau

James Barrineau

Head of Emerging Markets Debt Relative

Risk markets have digested surprisingly well what seems to be a near certain March rate hike by the Fed. Just nine calendar days ago, odds for March were just below 35% according to the Fed Funds futures market. After Chair Yellen's speech today those odds ended the day at 94%. 30-year Treasury yields seem stuck in a tight 2.95-3.1% yield range and equities are near all time highs. Emerging market (EM) assets have had similarly benign reactions.

For EM investors specifically, efficiently pricing in so swiftly an expected change in Fed policy, in our view, could bode well for local currency investing going forward. The dollar index fell after Yellen's speech, which is an encouraging sign if the cause is market expectations that the dollar's advance may be muted if a near-term rate hike trims growth prospects and precludes more aggressive hikes later.

A further beneficial factor for EM FX that may not yet be priced in is if fears about protectionist trade policies from the US prove to be unfounded. In conversations with clients, we sense that this particular point represents a big part of the argument against investing in EM in general. On Friday, the new Commerce Secretary Wilbur Ross suggested that the Mexican peso might respond favorably to a NAFTA deal, and made other remarks that clearly suggested an adversarial renegotiation was not likely. The peso, already a top performer year to date, rose nearly 2.5% on the day on the back of those remarks, clearly outpacing other global currencies.

Those remarks, and the subsequent reaction, may offer some comfort to investors who think EM would disproportionately suffer under a protectionist regime. Of course, it is still early days. What is becoming clearer is that such a regime may wind up renegotiating existing bilateral trade deals at the margin to provide a "win" for the US but not leading to significantly negative outcomes for a trading partner such as Mexico. Increasing evidence in that direction also suggests to us that an outright trade "war" with China would be unlikely as well. If that is the case, we believe EM assets that are priced for more negative outcomes have the ability to outperform, especially given that other parts of the opportunity set (and risk assets globally) remain priced for favorable outcomes.

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.