Fixed Income

EMD Relative weekly notes: Week Ending March 8, 2019

Week Ending March 8, 2019


James Barrineau

James Barrineau

Head of Emerging Markets Debt Relative

Sometimes emerging market debt correlates with US treasury bonds. Over longer periods it correlates with USD trends, but sometimes it correlates with general risk appetite. When it moves in tandem with the latter, it is the least problematic period for the asset class.

Figure 1 shows the spread-to-US treasuries of sovereign dollar bonds (in green) with the S&P 500 stock index in white. Near-term correlations are pretty clear:  when it is “risk off” in stocks, EM spreads tend to widen. We call this the least worrisome because risk assets tend to decline in tandem; parts of EMD will decline (most reliably non-investment grade bonds and, at times, currencies) but the declines are likely not to be idiosyncratic to the asset class. Investors who define risk off phases as a reason to shed or avoid EMD are missing a broader point, and if their actions were consistent with that view they should be shedding risk in general—primarily US equities. Parts of EMD will likely offer the potential to generate positive returns in this environment, we believe, primarily single-A rated credits in both corporate and sovereign flavors.

Figure 1

Source: Bloomberg. Chart depicts the Standard & Poor’s 500 Index (RHS) and the JPMorgan EMBI Global Spread Index for the period of December 6, 2018 through March 7, 2019. Performance shown reflects past performance, which is no guarantee of future results. Actual results will differ from index results.

What should cause investors to avoid or shed EMD risk is a sustained, strong dollar trend. This week's move by the European Central Bank to a more dovish stance was thus problematic even outside of general risk appetite, since it strengthened the dollar. However, the big jobs number miss on Friday—and the already-elevated level of the dollar—has caused a Euro recovery and a softer dollar. Analysts are busy explaining away the large miss, but it arrives with a consistent theme of weaker data and soft forecasts for Q1 GDP in the US.  

We do not see the fundamental differential in growth between US and rest of world as widening, and with an already elevated dollar (likely causing even slower growth in the US going forward) it does not seem to us likely an idiosyncratic move lower to broad EMD assets over an extended period is likely.  

That is what investors should be focused on, and if we turn out to be wrong and US growth firms we would then suggest we are in a negative EMD environment.

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.