EMD Relative weekly notes
Week Ending May 25, 2018
This weekend marks the unofficial start of summer for the US, and inemerging market debt—while things are not quite summer hot—the temperature has definitely migrated to warm this week:
– Retail EMD bond fund flows were positive this week, ending the longest stretch of outflows (five straight weeks) since November 2016.
– Fed minutes suggested a bit more dovish path ahead. As a result the market essentially removed the pricing in of a third, further additional hike this year, causing bonds to rally across the curve—particularly in the two-year range. We think this should slow the ascent of the US dollar, the key contributor to EMD softness since April 16.
– The Citi surprise economic index continues to show US economic releases coming in softer than analyst expectations—another headwind for further US dollar advances.
– The chart below shows the dollar index versus EMD sovereign dollar yields. Slowing momentum in the dollar's rise has resulted in debt yields reaching its peak, for now.
– The two big sore spots in EM—Argentina and Turkey—have now responded to market pressure with policy actions, both raising interest rates aggressively. While it is too early to tell if these countries are out of the woods, we believe neither is currently a default candidate and much of the preceeding market volatility in EM was a response to policy inaction.
– We noted earlier that local EM yields reached a flat level with dollar yields on an index basis for the first time since 2008. This week those yields widened by 28 basis points, finally rewarding investors for taking on local currency risk instead of simply dollar bond risk. We expect the yield differential to head towards the approximate historical average of 100 basis points which should help stabilize currencies further.
– US high yield has outperformed EM dollar debt year-to-date by nearly 500 basis points, a massive margin in traditionally correlated risk assets. If history is any guide, that gap may narrow.
Source: Bloomberg, JPMorgan. DXY Index is measured on the right hand side, and JPGCBLYD (JPMorgan EMBI Global blended Yield) is measured on the left hand side. Data as of May 23, 2018. Past performance is no guarantee of future results.