EMD Relative weekly notes: Week Ending February 8, 2019

Week Ending February 8, 2019

11/02/2019

James Barrineau

James Barrineau

Co-Head of Emerging Markets Debt Relative

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This week witnessed the biggest asset class inflows since July 2016. Flows are definitely following performance, with US dollar bonds up over 6% since December, and local currency bonds up almost exactly the same level.

However, this week markets are taking a breather. After a 75-point drop in spreads-to-US treasuries, markets have given back about 11 of those as of this writing. What are the conditions under which investors should worry about the correction extending significantly enough to materially impact potential 2019 gains?

  • The risk-free rate cycle endpoint is well defined—a plus. Having a center of gravity around 3% allows investors to more comfortably assess value if EM debt spreads widen much more from here, limiting downside in our opinion
  • The dollar remains well-behaved—a plus. US equity sell-offs, judging from the evidence of last year’s fourth quarter, tend to produce a weaker dollar which has helped EM currencies deliver positive returns
  • But perceived growth differentials matter—a caution. Speaking about the dollar is talking in shorthand—it is always the dollar on a relative basis versus other developed countries. The dollar soared in April of last year when strong US growth coupled with weak European numbers

That is why we think for now that US bad news is, broadly speaking, good news for EM investors. A market shift to pricing in a more aggressive Fed is the worry, and corrections based on other factors should be treated with caution, but not taken as reasons to abandon the asset class.