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Tuesday 19 March 2024

Global bond markets rallied after the US Federal Reserve (Fed) signalled on Wednesday what financial markets had been pricing in for months: the central bank will most likely retract from its rate hiking plans this year, given the global economic slowdown, lower oil prices and generally muted domestic inflation. The Fed also indicated its balance sheet may not shrink as much as expected as it needs reserves to meet rising demand from national banks (required to own more Treasuries to strengthen their coffers). This dovish-squared message reminded investors of 2016, when previous Fed chair Janet Yellen was on course to start normalising rates 8 years after the financial crisis, but refrained from doing so, providing a favourable backdrop for risk assets (more below).

US inflation-linked securities rallied as the absence of higher rates may stoke inflation, while the US High Yield (HY) spread over Treasuries has now plunged to 430 basis points (bps), down from 537 bps earlier this year. Emerging Market (EM) currencies flew as the dollar fell: the Indonesian rupiah rallied more than 1% yesterday as the country embarked on defensive interest rate hikes last year to protect its currency while the Fed was raising rates, so investors are now speculating that rate cuts this year are possible. Sovereign bonds also outperformed, with the Treasury 10-year yield falling back to 2.66%, down from 2.78% only last week. Oil gained.

Heading up:

Markets beat the Fed – again: Over the past five years, investors have challenged the Fed’s optimistic growth and inflation forecasts, pricing in a much lower probability of monetary tightening than the central bank. Every year they have been right;, US inflation has failed to gain real traction and as last year’s tax cut-fuelled growth is starting to wear off. This is not the first time that the Fed backtracks on its plans: in 2016, Yellen was planning a few hikes after lifting interest rates in December 2015 – the first hike since 2006. The Fed, however, had to shift gears as the Brexit referendum, plunging oil prices, tensions around the liquidity of a major European bank and a slowdown in China threatened global growth and kept inflation subdued. The same pattern seems to be now at play: low energy prices, a slowdown in China and tensions in Europe (still Brexit). Investors were quick yesterday to snap up risk assets, given their reaction to a Fed-on-hold in 2016: as seen in the chart, HY spreads tightened by 400 bps in 2016, while the premium that investors demand to hold EM sovereign debt also dropped. Spread levels are lower now, but some investors believe that the higher coupon typically offered by risk assets could deliver positive total returns in the absence of any price drop derived from a rising base rate.

HY: Fixed or Floating? Global floating rate HY debt performed better than fixed-rate HY over the past six trading days as some investors were still counting on the Fed to hike rates this year. Whether this will now change following Wednesday’s statement is yet to be seen, as plenty of challenges remain – geopolitical tensions or an escalation of global trade wars could lead to higher rates, an environment in which floating debt typically outperforms. Investors might also choose the lower-beta floating rate market if the economy deteriorates more than expected. For an analysis of the two assets classes and a simulation of how each responds to interest rate and spread changes, don’t miss M&G fund manager James Tomlins’ insightful blog: High Yield in 2019 – floating or fixed?

Heading down:

US dollar and US yields – parting ways: The correlation between the US dollar and 2-year Treasury yields has plunged to almost meaningless levels, after being at a stronger 0.45 (out of a maximum of 1) in the early 2000s – it has declined ever since. As seen in the first chart, the relationship between the two seems to have broken down over the past three years, as 2-year Treasury yields (blue line) have risen, reflecting strong economic growth, but the dollar (orange line) has not matched this move, remaining relatively around the same level. The US currency has failed to mirror the improving domestic economy, dragged down by growing fiscal and external deficits and also as China’s renminbi is challenging the greenback’s world supremacy status. Willing to internationalise its currency, China is encouraging other countries to write commodity contracts in renminbi and also lending large amounts to Asian and African countries in its currency. Some investors argue this challenge will still take years to materialise, while others focus on the lower demand for US assets from China and Japan, whose holdings of US Treasuries are in decline given the presently high hedging costs (a consequence of the big interest rate differential). If the US dollar, largely determined by foreign demand, is not matching US economic moves – does this mean that the rest of the world is less responsive to what is happening in the US?

European inflation expectations – party pooper: In the midst of January’s risk-on optimism, the one indicator that keeps falling is European inflation expectations, which dropped to 1.495% on Wednesday, the lowest level since 2016. European economic data remains dismal, with Germany’s economic ministry cutting the country’s growth forecast for this year to 1.0%, down from a previous 1.8%. With France’s economy challenged by ongoing protests, Italy’s protracted fight with Brussels over its budget deficit, and the possibility of a disorderly Brexit still on the cards, few investors seem to be betting on European growth. Four years after the European Central Bank launched its multi-billion euro monetary stimulus – the region’s inflation expectations are even lower than then.

As we all know, 2018 turned out to be a tough year for most asset classes, not least High Yield (HY) bonds. The sell-off in the fourth quarter was particularly quick and brutal compared to the recent lulls of benign volatility under the blanket of central bank largesse. Global HY lost a few percentage points in pure local currency terms in 2018, whilst the lower beta and more senior secured heavy Floating Rate Note (FRN) market held up a little better with a loss of just under 1%. This was a timely reminder that the HY FRN market (which shares many risk characteristics with the senior loan market, including its senior secured nature and floating coupon) is typically less volatile than conventional fixed rate HY bonds in periods of market corrections.

Where does that leave investors looking at 2019? Should they favour floating rate or fixed rate HY?

To try and answer this question, I’ve outlined below some total return scenarios based on different changes in spreads and interest rates. These scenarios also take into account an estimate of one-year currency hedging costs in order to give a fully hedged return. I have assumed a 1.5% default rate, with an average recovery rate of 30% for the fixed HY market and a higher 60% for the floating market. I am also assuming that any change in yields is purely a steepening / flattening move, meaning that there are no further rate hikes over the following 12 months. See below the 3 scenarios – for fully hedged US, Euro and UK-denominated FRNs and HY bonds.

What can we infer from the above?

  1. For USD investors, the risk-reward from an absolute perspective starts to look interesting – the breakeven on spreads is sufficiently attractive that you need over 200 basis points (bps) of spread widening before the FRN market starts to give you losses. For context, this means spreads in the region or around 650 bps and an all-in-yield of near 9% – arguably a level that prices in a recession. In the case of the higher spread duration fixed rate market (it has higher sensitivity to spread changes), outright losses start before, at the 150 bps level (circled). All in all, this suggests a reasonably attractive risk / reward pay-off with potential returns in the high single digits and low double digits. For EUR and GBP investors, the picture is marginally less supportive, given the lower income after the cost of hedging is taken into account.
  1. Under a bullish scenario, with a big tightening in spreads and a back-up in yields, the low interest rate duration of FRNs works quite well as any rise in government yields would not have an impact on returns (as the coupon resets periodically to match short term money market rates), whereas the longer duration of the fixed rate market acts as a negative drag if rates rise (blue circle).
  1. Under a bearish scenario, with wider spreads and lower yields, the lower spread duration of the FRN market also plays in its favour relative to the fixed rate market (dashed blue circle).
  1. Fixed rate HY outperforms if both yields and spreads fall (black box), something that could be consistent perhaps with a return to monetary stimulus such as Quantitative Easing (QE).

Given the relative strength of the US and global economy, a return of QE is quite unlikely – in my view, this should give an edge to FRNs in most likely return scenarios. I do have to caveat that this is based on several assumptions, so should be taken as theoretical. Also, there are other variables that would also have an impact, including FRN’s lack of capital upside, as they trade close to par, and any increase in default rates above 1.5%.

Having said that, the inherent resilience of FRNs, through their low spread and interest rate duration, could be a good tailwind for the asset class in 2019. This could well be a good year for floating rate High Yield.

Not that we needed anybody’s reassurance, but the UK government’s decision that pension fund trustees must consider financially material ESG (Environmental, Social and Governance) factors in their assessments, definitely helps those who believe that sustainability is becoming a need more than a choice – for society and investors alike.

In my view, an ESG lens can help monitor qualitative risks and assess corporate management style as well as priorities in order to prevent single name idiosyncratic drawdowns. ESG considerations are particularly important for High Yield (HY) issuers, usually more leveraged and therefore more likely to amplify any positive or negative news.

A Barclays study recently found that HY portfolios with a high-ESG tilt tended to outperform, with the Governance component being the most important of all. Intuitively, this makes sense as lending to well-run companies, where interests are aligned with bondholders, should pay-off in the long run.

We should also remind ourselves that what’s good for the share price is not always good for credit risk. Take for example a private equity ownership which incentivises maximum leverage and/or major shareholder returns.

While performance links of Environmental and Social factors are less clear, I still argue that companies must also consider the externality of poor environmental and social practices in the long term. The short-term cost saving of cutting wages or avoiding clean-up costs is increasingly outweighed by the long-term financial damage of such actions.

Investors are increasingly focused on these qualitative factors and this, combined with the explosion of big data, is bringing a level of transparency that is leaving many faces blushed. Excessive behaviour will be more quickly punished as non-financial information is now readily available and can be measured in real time. For instance, the presence of social media means that even in remote areas of Africa, a company that leaves a mine full of contaminants might not be granted access to exploit a new mine in Chile. A handful of ESG data providers have already emerged to tap increasing demand and I forecast a bright future for those service providers.

However, asset managers need more than third party ESG research. Here are some recommendations that may help:

  1. Define the financially material ESG factors: The ESG data provider’s definition of material ESG factors for an industry as well as their weight for the overall ESG assessment is highly subjective and might disagree with the asset manager’s opinion. For example, MSCI’s Governance quality score focuses on issues such as board composition and executive compensation. On the other hand, Sustainalytics prioritises other factors, including the company’s handling of environmental and social issues, which results in different outputs. As more and more providers offer ESG solutions, more methodologies will be available to digest for data users potentially producing   conflicting results. Experienced in-house sector analysts are in my view best placed to assess what they consider the most important financially relevant ESG issues for an industry.
  2. Review: ESG data providers tend to assess thousands of issuers, something that reduces score revisions to about once a year – and in such case, there seems to be little probability of any rating change. The Barclays study says that an issuer with a top-tier ESG score at the beginning of a year had a 79% probability of keeping it a year later (according to MSCI), and 88% (according to Sustainalytics). This status-quo-friendly approach makes me question whether ESG scores might be more a reactive than leading indicator – what they are supposed to be. Again, I believe that internal analysts feeding up-to-date research into a tailor-made ESG framework to monitor (potential) holdings might be more efficient than using any external sources.
  3. Engage: Engagement activity is not undergone by ESG data providers which is why asset managers need to step in and have a dialogue with companies to ensure that they walk the talk. Compared to Investment Grade (IG) businesses, HY issuers are more likely to engage with bondholders and open to negotiate the terms of an issue, given the debt market is often the primary source of financing. Big HY lenders should be well placed to make an impact by helping drive change.
  4. Beware of the information bias: IG issuers tend to have a better ESG rating than their HY peers, leading many investors to assume a positive correlation between credit and ESG – as seen in the chart below:

In principle it makes sense that better ESG performance leads to higher profits, and therefore to a stronger balance sheet and a better rating, but I don’t think this logic holds given that ESG data is not efficiently priced into markets yet.

I think IG’s better ESG performance is largely due to an information bias: IG companies are usually blessed with a PR department that showcases the company’s ESG efforts; in contrast, and according to a recent PRI report (“ESG Engagement For Fixed Income investors”), only 20% of global HY issuers reviewed and confirmed MSCI’s summary of the data it uses for their ESG scores, dropping to just 3% for privately-owned companies. This may mean that the HY ESG data might not capture the full picture and therefore may be unsuitable to draw any conclusions from. Asset managers with big in-house analyst teams may be able to access more relevant but less available data in order to reach a more comprehensive conclusion.

All in all, while ESG data providers can offer an initial framework and some guidance, active asset managers need to up their ESG capabilities to maximise alpha for their investors.

Few investors would have bet on emerging market (“EM”) corporate bonds fifteen years ago. In 2004 the EM external (also known as hard-currency) corporate bond universe was relatively small at approximately US$ 270bn. By 2009 the asset class had more than doubled to US$ 600bn driven by strong economic expansion across developing economies notably the BRIC countries. Since the global financial crisis, emerging market corporate bonds have experienced the strongest growth across fixed income markets (Figure 1.) with the size of the external EM corporate bond universe increasing to US$ 2.2 trillion by the end of last year.

The rise of EM corporate bonds has resulted in it becoming a standalone asset class (Figure 2.) and therefore a new area of focus for global credit investors. For instance, EM high-yield bonds now account for 23% of global high yield investment opportunities compared to just 8% in 2009; I’m confident that the share of EM in global indices is going to continue to increase over the medium term. The much larger EM corporate bond universe in local currency has also posted impressive growth (+300% since 2009) and is approaching US$ 8 trillion in size, comparable to the EM local sovereign bonds and larger than the US investment grade market. Yet, the “investable” part of this market remains small for global investors.

This outlook explores the three segments that are worth watching over the next few years: the mature EM external corporate bond universe, its fast-growing high yield segment, and the enormous but illiquid EM local corporate bond market.

Figure 1 (left). Figure 2 (right).

Emerging Market External Corporate Bonds: The Established Market.

The impressive growth of US dollar denominated EM corporate bonds in the past decade (Figure 3.) has been a long time coming, especially given the small size of EM fixed income markets compared to their contribution to world GDP (over 50%). Issuance in US dollar, and other hard currencies, was the result of three distinct factors. Firstly, some EM issuers operate in “dollarized” sectors (e.g. commodities) or countries with pegged currencies, like UAE, hence naturally preferring to borrow in a currency that doesn’t create an FX mismatch on their balance sheet. Secondly, funding needs for investment increased in line with EM economic expansion but local debt markets (bank loans and bond market in local currency) lacked depth. Long-term and sizeable debt financing for large corporates – such as utilities – in general were not available locally. EM issuers therefore started to look at international bond markets. Thirdly, market technicals improved as demand from global bond investors emerged, in addition to dedicated EMD managers, due to diversification benefits after the global financial crisis hit many portfolios.

Figure 3. (left) / Figure 4. (right)

From a credit standpoint, bond stock growth has been driven by investment grade (IG) and high yield (HY) issuances equally. Nevertheless, the split still favours IG credits. As of January 2019 HY credit represented 36% of the bond stock (43% for JP Morgan’s CEMBI BD index). Quasi-sovereign issuers account for approximately half of the universe and are now worth just above US$ 1 trillion – a similar size to EM sovereign bonds in hard currency. For more information on Quasi-Sovereign bonds you can read this blog: https://bondvigilantes.com/blog/panoramic-outlook/quasi-sovereigns-in-emerging-markets/

One remarkable trend in the asset class has been the material increase in Asian bonds as a share of the universe (Figure 4.) driven by enormous issuance from China in the past 10 years. Excluding Asia the asset class shows more modest growth since 2011 (+83%) and is only marginally up from 2014 (+6%). Asia external corporate, including quasi, bonds were worth US$ 1.1 trillion at year-end 2018 – which is bigger than the whole EM external sovereign bond universe – and 51% of the total EM external corporate bond asset class. This is in strong contrast with Asia being only a small share of EM external sovereign bond stock. With its US$ 650 billion external corporate bond market China represents 30% of the asset class (although capped at 8.1% in the CEMBI BD index) and is the largest economy among the 50 countries in the EM index. Mexico (8.8% of total bond stock), Brazil, Korea, Russia, Hong Kong, UAE and India are also large country contributors. Thanks to these diverse geographies only net negative supply from China would alter the size of the asset class.

In terms of sectors, as measured by the CEMBI BD index – Figure 5., the impressive growth of Asia has had little impact on the diversity of the asset class. Financials remain one-third of the index and unlike developed market financials are less exposed to contagion risk (e.g. Colombian banks are unlikely to be impacted by a banking crisis in Indonesia) although China’s financial institutions are systemically important for Asia. Commodities account for about 20% (Oil & Gas 14%, Metals & Mining 7%), usually smaller than what most investors would expect from an EM debtor. TMT and Utilities are also large sectors and in line with the economic expansion, the Consumer sector (9%) has been growing at a faster pace than Industrial sectors.

Figure 5. (left) Sectors / Figure 6. (right) Returns vs Vol

Looking at performance (Figure 6.), EM external corporate bonds have generated decent returns in their relatively short history. Since 2004, last year’s total return of -1.65% (JP Morgan CEMBI BD index) was only the third year with negative returns (after 2008: -16.8% and 2013: -1.3%) whilst the cumulative return during the period (2004 to Oct 2018) was 145%. The index’ annualised total return was 6.1% whilst annualised volatility stood at 7.9%. For an asset class that has an average credit rating of BBB-, returns look higher than developed-market counterparts but so does volatility. The asset class’s Sharpe Ratio of 0.6 appears average, if not better, compared to other asset classes during the same period (2004 to October 2018) but lower than EM sovereign external debt (0.7), US HY (0.7) or US IG (0.7).

Emerging Market High Yield Bonds: Size Matters.

The substantial increase in EM external corporate bonds has had implications for other asset classes, notably Global High Yield. Historically, emerging market corporates have been a small allocation in global high yield investment mandates where many primarily focus on the US market followed by the European high yield bond market. In 2009 investors justified the smaller allocation to EM by the 8% weight in the index (Figure 7.). In 2015 EM HY surpassed in size European HY in the index due to two main reasons. Firstly, EM high yield issuance increased significantly between 2009 and 2015, in line with the rest of the EM external bond market. Secondly, a lot of existing EM bonds were downgraded to high yield after many sovereign issuers lost their investment grade status (e.g. Brazil, Russia) in the aftermath of the Taper Tantrum. As such, new issuers, like Brazil’s national oil company Petrobras or Turkish banks, appeared in the global high yield index.

Figure 7 (left) / Figure 8 (right)

Today, EM HY bonds represent 23% of the BofAML’s Global High Yield index and the outlook points to an increasing share of EM going forward. Another interesting element is the index composition which demonstrates that emerging markets are not small weights in the index. Emerging market issuers account for 20% of the market value of the top 150 issuers (representing 47% of the global high yield index) Furthermore, Petrobras and Israel-based pharmaceutical company Teva are respectively the first (2.1%) and fifth (1.2%) largest issuers in the index.

Surprisingly, US investors nevertheless still avoid EM with an estimated holding of 2.2% of EM HY bonds in US high yield portfolios. But this does not seem to be driven by valuations, since the range of EM HY holding has fluctuated between just 2% and 4% since 2011. The underweight stance is rather explained by geographic and sector bias of US and European high yield managers. This tends to be confirmed by significant holdings either in countries that are geographically close to the country of origin (e.g. Mexico) or in sectors that have global reach (e.g. commodities, TMT) and for which non-EM high yield analysts and portfolio managers feel more comfortable. The perceived lower credit quality and additional top-down approach required to analyse EM corporate bonds are also factors that could explain why the asset class remains under-represented.

Yet, EM HY default risk (Figure 9.) and recovery values look no worse than their US and European counterparts. You can read more here: https://bondvigilantes.com/blog/panoramic-outlook/emerging-market-corporate-bonds/ On the returns front, the trend since 2008 suggest that US and EM HY returns can be very diverse (Figure 8.). As the size of EM HY continues its march higher, asset allocation within global high yield bond funds is likely to become a much more important driver of future performance.

Figure 9.

Emerging Market Corporate Bonds in Local Currency: the niche market.

It may be surprising to developed market investors but the size of the emerging market local currency bond universe (sovereigns + corporates) is almost 5 times larger than the external bond market (Figure 10.). But as ever in emerging markets, don’t be fooled by appearances. The fastest-growing market has been the local-currency corporate bond market which now totals approximately US$ 7.8 trillion equivalent – that compares with US$ 2.2 trillion of EM external corporate bonds. Yet, local corporate markets remain niche because of two main drivers: currency risk and thin liquidity.

There are two types of EM local-currency corporate bonds: local and global local bonds.

Local local corporate bonds are bonds issued locally subject to local taxation and regulatory rules, which require domestic custodian accounts. They account for more than 90% of the EM local corporate bond universe with half being onshore Chinese debt. Local bonds appeal most to domestic investors because they don’t have to take the currency risk. The bonds in general also tend to offer a yield pick-up over local sovereign bonds and knowledgeable local participants (brokers, traders, investors, analysts) help navigate the market. Foreign investors conversely may find it difficult to invest because of taxation, currency risk, thin liquidity and limited availability of information outside of the country.

Figure 10.

Global local corporate bonds are local bonds that settle through Euroclear where investors don’t require local accounts and in general are tax-free bonds. They account for less than 10% of the local corporate bonds. This market also includes dual-currency bonds which are local bonds that settle in a different currency (often US dollar). They are often coined with peculiar names, e.g. masala bonds in India or komodo bonds in Indonesia. Foreign credit investors usually favour this market because it removes the tax burden. Liquidity nevertheless remains a big hurdle. Roughly half of euro-clearable bonds are not index eligible  mainly because of the lack of liquidity (no active pricing or bond size filter). Taking BofAML’s LCCD index as a proxy for the most liquid names, the “investable” global local bond universe stood at just US$ 245 billion. This is only a fraction of the optically huge US$ 7,800 billion local EM corporate bond stock and arguably most index bonds will see some liquidity only in small size (i.e. below $1 million equivalent) in sharp contrast to much better liquidity elsewhere in EM debt. Foreign investors also remain exposed to currency risk. Analysis of the index shows that the volatility of the asset class is nearest to EM local-currency sovereign bonds and furthest to EM external corporate bonds. This means that the currency risk – as opposed to corporate credit risk – is one of the primary drivers of volatility whilst liquidity is poorer than the very liquid EM local-currency sovereign bond universe. Furthermore, the lack of country, and currency, diversification may not be suitable to all portfolios. China, Mexico, South Africa, Russia, Malaysia, India, Colombia and Singapore accounted for 85% of BofAML’s LCCD index as of 15 January 2019. As a final point of note, the lack of index research and coverage by rating agencies (28% of the index is not rated) may be additional barriers for foreign investors who may favour the more diversified and liquid external corporate bond market.

When the presidents of the US, France and Britain cancel their trip to the World Economic Forum at Davos – the mecca of globalisation over the past two decades – to face domestic challenges, no wonder investors are worried about falling global trade, inward-looking policies and hence, lower global growth. This week’s data seems to vindicate such fears: US-China trade tensions escalated on speculation that a meeting had been cancelled; China posted 2018 growth of 6.6%, the slowest pace in almost three decades; US housing data was dismal and Germany’s Zew survey of economic growth prospects hit a four-year low. The International Monetary Fund (IMF), which has warned for months that less trade could hit economies, cut again its global growth forecast for 2019 to 3.5%, down from a previous 3.7%. The reduction was mostly due to slower growth in Germany and Italy, and a deeper-than-expected contraction in Turkey. The IMF kept its US growth forecast for this year at 2.5%.

Against this backdrop, and the market sell-off late last year, central banks are sending dovish messages, especially the US Federal Reserve (Fed). Over the past five trading days, the anticipation of lower or at least stable rates helped fuel risk assets, especially US Investment Grade (IG) companies, which particularly suffered in 2018 due to massive supply and deteriorating credit quality. High Yield (HY) spreads continued to tighten this week, taking their year-to-date gain to 3.7%, more than offsetting their 2018 loss of 2%. Emerging Markets (EMs) fell behind this week, after a very strong start to the year and as the US dollar gained against most developed and developing currencies, reflecting the US’s better growth prospects. US inflation expectations, on a downward spiral since October, have recovered in January after the Fed signalled a potential halt in its rate rising cycle, a move that may generate inflation. Also underpinning inflation expectations, oil surged to $53 per barrel, up from $45 at the beginning of the year.

Heading up:

Credit – bargains after the sell-off? The sharp rise in global credit spreads last year has brought yields to a level that some investors say are high enough to compensate for the risk taken. As seen in the chart below, developed by M&G’s Fixed Income Investment Specialist team, leading global credit classes were trading below the mean level of a 20-year range (red circle) at the end of 2017. One year and a big sell-off later, only US credit is right at that 50% level, while sterling and euro-denominated corporate debt is trading closer to their cheapest level since 1999. The cheapest of all is Single-B rated pound debt (considered HY), which trades only 25% below its lowest price over 20 years, hit by Brexit concerns and by gloomy European growth forecasts. This outlook is also weighing on European credit – as seen by green line expanding further out in the right-hand chart. Lower valuations mean that investors have a bigger cushion before losing money from the credit component of the bond: for instance, for A-rated euro debt, which has a spread of 123 basis points (bps) over the risk-free rate and a spread duration (sensitivity to spread changes) of 5.12 years, the spread would need to widen by a further 62 bps before investors lose money (again, on the credit component of the bond). Such a move would take the spread to 185 bps, a level that has only been breached twice over the past 20 years: during the 2007-2008 financial crisis and during the European sovereign debt crisis in 2010-12.

Pound & UK economy – defying gravity: At the height of the Brexit uncertainty, when Britain’s scheduled departure from the EU is barely two months away and still there is no plan, the country posted some of its strongest data of recent times: unemployment dropped to 4%, more than expected and the lowest since Abba and The Bee Gees topped UK the charts (1975). Wages also rose, as the labour market tightens, and sterling rallied against a rising US dollar – it is up 2.27% so far this year, making it the top performing G10 currency against the greenback. The optimism comes as investors are pricing in less chances of a disorderly Brexit or other alternatives, such as a general election or a second referendum. UK linkers, however, didn’t join the optimism, as their 3.6% drop over the past five trading days makes them the worst-performing Fixed Income asset class of the 100 tracked by Bond Vigilantes Weekly: the House of Lords proposed changing inflation linked bonds’ reference index to one that tends to be a bit lower, leaving investors less protected. For more details, don’t miss M&G fund manager Ben Lord’s “The war of the indices: Which inflation measure to use?” post.

Heading down:

US rate hike forecasts – Fed on hold? Market-implied chances that the Fed will raise rates in March have plunged to meagre levels, down from more than 60% about two months ago. Fed officials have publicly recognised they are considering a halt in their interest rate rising cycle, following lukewarm economic data, protracted low inflation and the severe market sell-off in November and December last year, something that can hit consumer spending given the high degree of ownership of financial assets by US consumers. The ongoing month-long US government shutdown is also expected to hinder activity. As a result, corporate bonds are enjoying a strong January, on hopes that their positive return on invested capital will continue to be above borrowing costs, keeping their investments plans profitable. According to economic forecasts, US capital investment is expected to grow by 3.7% this year, more than any other Gross Domestic Product (GDP) component. As seen in the chart, US High Yield spreads have tightened in January, matching the drop in rate hike expectations.

Europe’s inflation expectations – back to square 1? Just as the European Central Bank (ECB) is preparing to withdraw its multi-billion euro QE support measures, inflation expectations have plunged, a reflection of the region’s dismal prospects: the IMF said earlier this week that lower European growth would drag down the global economy, especially due to the slowdown in Germany. Europe’s economic engine is being hit by soft private consumption and weak industrial production following the introduction of revised auto emission standards. Italy also faces weak domestic demand and higher borrowing costs, while French growth is being challenged by the ongoing “yellow vest” protests. The ECB’s favourite inflation expectations measure, the 5-year/5-year euro inflation swap rate, has dropped to 1.53%, the lowest level since June 2017, and about the same level it had in March 2015, when the ECB unveiled its stimulus programme.

After a lengthy review, Britain’s House of Lords has finally said that the inflation index presently used to price inflation-linked securities, train fares or student loans should be replaced. Instead, the Consumer Price Index (CPI) should become the new benchmark, as it includes more items and has an overall higher credibility. So far, so good – except if you are an investor.

The statistics body has acknowledged the limitations of the currently used Retail Price Index (RPI), which has already been de-recognised as an official national statistic, but still, it would rather improve it. In any case, this is not a Lords vs ONS fight, as any change is ultimately in the hands of the Chancellor, who has had this issue on the table for a number of years.

We have discussed the difference between RPI and CPI (known as the “wedge”) many times before, but just as a reminder, RPI is generally higher not only because it is calculated using a different formula, but mainly because it contains a housing component (prices and mortgage interest payments), while CPI does not. Over the long term, and reflecting Britain’s booming housing market, RPI has been around 100 basis points (bps) higher than CPI.

What is the problem with this? For a long time, many have argued that this difference leads to “index shopping,” whereby expenditures gravitate towards the (lower) CPI, while revenues and income generally gain if linked to the higher RPI gauge. Index-linked gilts reference the RPI, the higher number, hence these securities immediately dropped when the upper House delivered its recommendation this week: linker (or inflation-linked bonds) yields spiked to their highest level since November, as seen in the chart below.

The House of Lords said that RPI should correct its 2011 calculation of clothing, a move aimed to reduce the price recognition of some items, but which has led to the opposite. This was an easy and obvious recommendation: was this calculation to change, RPI could fall by 25 bps or, according to some estimates, even 50 bps! All else remaining equal, the tweak would see breakeven rates (used as a proxy for inflation expectations) drop by 25-50 bps, making real yields take the pain (real yields rise as inflation expectations fall). In money terms: a 25-50 bps drop in RPI would see the price of the 2068 linker bond fall by 12% to almost a quarter!

More importantly, the House also recommended that new linker issuance should reference the CPI rather than the RPI. Five years ago, a consultation considered removing the RPI, but the implications of doing so were so severe that the commission in charge decided to stay put. Breakevens soared in relief. If this changes now and linkers end up referencing the CPI, and assuming a wedge of 100 bps, the price of the 2068 linker would almost halve.

Thankfully for investors, big regulatory changes in financial markets tend to be a bit more subtle: it is more likely that the Treasury announces an intention to issue CPI-linked bonds, which could co-exist with RPI-linked ones, while ceasing any new RPI-referenced issuance. This would still take a number of years, as preparations would be needed to prepare the market and to understand the implications. Following the Lords’ review and years of consideration, I am sure that the Chancellor and the Treasury are well aware that a simple switch from RPI to CPI might have a similar effect to the credit events so feared by investors – usually a negative change that diminishes an issuers’ capacity to repay debts. Bondholders would certainly lose – not a good thing for a country with a big current account deficit, something that makes it foreign-capital dependent.

All in all, I can only see rough times ahead as the wedge and CPI-referenced issuance are on the table. However, and in the short term, RPI-linkers might trade higher if issuance is ceased. Still, given the present rich valuations (breakevens are above 3% all along the curve), I expect more focus on the downside from here: if it is true that chances of a hard Brexit have diminished, one could expect a stronger pound limiting inflation growth. Still 12% below its level before 2016’s referendum, sterling has plenty of ground to make up – but that’s another story. Stay with us, I will come back with more comments as events unfold. They surely will.

Although world markets depend more on Fedspeak and China than on British politics, when the UK House speaker announced (in traditional centuries-old fashion) that the “noes” opposing the government’s Brexit plan had won – inadvertently, he helped reduce sugar levels in Europe. Investors’ interpretation that a hard or disorderly departure from the EU is now less likely strengthened the pound and lifted gilt yields – the latter, on lower safe-haven, chaos-escaping demand. Britain’s relief rally capped a strong start to the year, with more than 90 out of 100 Fixed Income asset classes tracked by Panoramic Weekly delivering positive returns. Only long US Treasury bonds and traditionally rock-solid assets such as Swiss and Singapore sovereigns have lost money to investors so far this year – less likely as they are to join a cheerful party.

In the US, the ongoing government shutdown, lukewarm economic data and mixed bank earnings vindicated the recent dovish tone of the US Federal Reserve (Fed), dragging down future rate projections even more: the market-implied probability of a US rate hike in March has now plunged to 0.5%, down from 41% in early December. This year’s oil rally and China’s reassurance of its economic stimulus plans also helped underpin risk assets: Russian, Nigerian and Mexican bonds are up by more than 4.2% in 2019, while US High Yield spreads continued to tighten: after spiking by almost 1.5% in a dismal December, they are now back down to 446 basis points (bps), their level in mid-December. News from Europe were not as positive: gloomy German data reduced inflation expectations at the same time that China posted a record low current account surplus, confirming that lower Asian appetite is hurting Europe’s industrial bastion (more below).

Heading up:

Sterling – avoiding chaos: A lower likelihood of food shortages and collapsed roads brought relief to sterling as investors started ruling out a sudden and unorganised EU departure. While many options are still open (general election, second referendum, even no Brexit at all), the pound strengthened to 1.286 per US dollar, the highest since November. The level, however, is still 13% below its price just before the 2016 referendum, when it crashed 20% on prospects of higher inflation and lower growth in the country. As seen in the first chart, sterling’s value has been largely driven by Brexit politics over the past two years – only diverging just before Christmas, when the crucial Parliament vote was delayed, finally taking place on Tuesday. While the government and Parliament have spent more than 2 years debating on Brexit execution, growth and investment have dropped, while inflation has gone up (second chart). At lease, Britons have one reason to cheer: the market-implied probability of a rate hike in March has dropped to 3%, down from 43% in October last year, mainly due to falling oil prices. December inflation rose by 2.1% from a year earlier, the lowest level in two years.

Argentina – see who’s rising: A history of defaults, an ongoing IMF programme and a decade-long legal battle with funds trying to recoup their money are not deterring investors from believing in Argentina again: the Latin American country’s bonds have gained 7.5% so far this year, the best-performing mark among the 100 Fixed Income asset classes tracked. The central bank has been the first among world leading countries to move this year – it is slowly cutting down the reference Leliq rate, now at 57.4%, down from a peak of 73% reached in October, at the height of the country’s crisis. Engulfed in a recession and under a stringent IMF programme, President Macri is trying to bring the country back to normality, especially ahead of this year’s general election, scheduled for Oct. 27. Read more about this year’s EM elections, and other factors affecting the asset class this year, in Claudia Calich’s recent blog: “EMs: 5 key issues to watch in 2019.”

Heading down:

Probability of US recession? The Fed is becoming more dovish, interest rate hikes and inflation expectations are plunging and the New York Fed’s probability of recession index has climbed to 21%, the highest since 2008 – yet, credit spreads seem to tell a different story: according to Deutsche Bank Chief International Economist Torsten Slok, the premium that investors demand to hold US Investment Grade-rated companies has to reach 300 bps to trigger a recession (as seen on Slok’s regression chart below). This is well above the present level of 144 bps and not too far from a 30-year average of 134 bps. According to Slok, while manufacturing data points towards a gloomy scenario, other factors could still underpin the US economy or at least protect it from falling into recession – mainly the recent stabilisation of oil and equity prices, and the possibility that the US-China trade war might have already peaked. Capital expenditure is still projected to sustain growth over the next two years, as the Return on Invested Capital is still above corporate borrowing costs. According to market prices, the Fed will be on hold this year, backtracking from its present plans to hike rates twice more.

China’s current account and Germany’s economy – no coincidence: Germany’s economic growth slowed down to 1.5% last year, the weakest in five years, mostly due to lower global demand and disruption in its car industry, hit by new clean regulation. At the same time, China’s current account fell to a meagre 0.4% of GDP, a 20 year-low and a reflection of the country’s efforts to focus more on internal demand than on cheap exports. German carmakers and other industrialists are suffering from the shift, only exacerbated by last year’s increased trade wars. German woes helped drag down Europe’s general economic sentiment, which reached in December the lowest level in about two years.

Emerging Markets (EM) debt had a torrid 2018 as global macro risks (including general geopolitics and trade wars), softer EM growth and idiosyncratic stories (Argentina, Turkey), all repriced relatively expensive valuations at the beginning of the year. Are the new prices a better reflection of fundamentals? This will largely depend on the evolution of 5 key topics.

  1. China-US – upside surprise? The ongoing trade conflict has been a significant driver of global asset prices as the tension has hit global trade as well as corporate earnings (including Apple). If the present trade talks go nowhere, one should expect further global growth weakness, something which could affect EMs, as we highlighted last summer in “How vulnerable are Emerging Markets to trade wars?” For China, the conflict comes at a difficult time for the economy, as the cost-benefit of additional policy stimulus is lower than it was a decade ago, given the higher leverage in the system – inflation is good to cut debt, but comes at a very high competitiveness cost. Despite the negative headlines, investors should not rule out any potential positive tailwind: the US-China relationship could stabilise this year, having a positive impact on asset prices, including EM debt.
  1.  The US Federal Reserve (Fed) – more dovish, but higher issuance? Markets were quick to price in additional Fed hikes this year, but plunging oil prices, a dovish Fed and lukewarm data has made them now forecast the end of the tightening cycle. However, and in the absence of a significant US slowdown, treasuries appear to be pricing in little risk premia, especially since supply remains healthy – usually a negative for bond prices. US government debt is expected to remain high, given current projections of a US fiscal deficit and also because some natural buyers, including some central banks, have recently diminished their Treasury holdings. China, for instance, is not running big Current Account surpluses any more, hence it has less ability to park those extra dollars elsewhere.
  1. Elections and idiosyncratic risks – volatility and opportunity: There is a stream of EM general elections scheduled for 2019 which may bring a degree of volatility, and opportunity. In terms of potential market reactions, Argentina’s poll, in October, may be the most binary: pro-market incumbent Macri is likely to seek re-election (bullish outcome), but he might face former President Christina Kirchner (expect a negative market reaction if she wins), while the Peronist Party will also be contending (expect a neutral reaction if they decide to continue the IMF-led adjustment path and a negative reaction if they do not). Other elections in Ukraine (March), Indonesia (April), India (April/May) and South Africa (May), may also bring volatility. In other countries, key elections are now behind, so the focus has shifted towards the implementation (or not) of the promises made – for instance, we are monitoring the progress of Brazil’s much-expected pension reform, while expecting further clarity on Mexico’s economic policies. Elections of course are crucial as government action can either lead to or reduce potential idiosyncratic risks. As ever in EMs, avoiding those – usually the largest underperformers – is paramount. Last year, for example, the worst performers were not linked by any common theme, but suffered from specific, idiosyncratic issues, such as large financing needs (Argentina), plunging oil prices (Nigeria, Ecuador and Venezuela), or an unconvincing fiscal adjustment (Zambia and Costa Rica).

  1. Commodities – symptom or cause? Despite the common perception of a strong link between oil and EMs, developing nations’ sensitivity to oil prices is rather uneven. Should oil go up, Turkey, India and other importers will see a deterioration in their Current Accounts, while Middle East and other EM oil exporters (e.g. Russia, Nigeria) will benefit. Therefore, oil price volatility is likely to generate diverse asset returns. On the other hand, a significant decline in metal-based commodities tends to have a negative impact on most EMs not only because it hits exporters, but also because it often signals weak demand from importers (like top-consuming China), suggesting slower global growth. For instance, the slowdown in China’s property market has negatively affected steel and iron ore prices globally.
  1. Corporate fundamentals – the bright spot again? Low corporate default rates and credit improvements of corporate issuers were the bright spot of EMs last year (for more, don’t miss Charles de Quinsonas’ “Emerging Markets High Yield: is there value after the sell-off?”) Stronger earnings and disciplined capital expenditures resulted in a net debt reduction throughout the year: as of the end of June (latest data available), EM corporates’ net leverage was below 2.75x, down from 3.5x times at the peak in 2016. Looking into 2019, we believe corporate fundamentals will start stabilising, at the same time that EM High Yield default rates may pick up slightly to 2 to 3% (from less than 2% in 2018), on the back of tougher macro fundamentals in a few countries, such as Turkey, China and Argentina. Default rates are nevertheless likely to remain below their long-term average.

So, whilst global macro risks are unlikely to recede in 2019, the yield on offer by EM debt (around 7% in sovereign US dollar bonds) is at its highest level since the 2007-2008 Global Financial Crisis, raising prospects for improved returns relative to last year. In fact, since 1994, hard currency bonds have never posted two consecutive years of negative returns.

Local debt is a different matter, as currency adjustments often last for a few years depending on the economic cycle, monetary policy and the outlook of the balance of payments. However, and looking at valuations, the Current Account adjustment that has taken place in many countries and the rise in real yields, we believe that the bulk of the local currency correction is behind us. But, since hard currency debt has also cheapened, we remain neutral in terms of allocation between hard and local currency – 2019 will bring opportunities in both.

Goldilocks, one of investors’ favourite economic scenarios, seems to have returned in the new year after almost vanishing in 2018: a strong US jobs report and dovish comments from US Federal Reserve (Fed) chair Jerome Powell have reinstated the not-too-hot, not-too-cold environment that combines relatively low rates and good-enough economic growth – supporting risk assets. US High Yield spreads, for instance, have rallied 80 basis points (bps) so far this year, after widening more than 1% in a dark December. Equities have soared.

Optimism has been mainly triggered by Powell, who said on Friday that the Fed would be patient on its rate hiking path as inflation remains muted. Markets reacted with force: expectations of a March Fed hike have now plunged to 5%, down from 41% one month ago, while inflation expectations and the dollar fell. These tailwinds favoured Emerging Markets and their currencies, which rallied also on the back of more Chinese monetary policy easing measures, and despite soft data from the world’s second-largest economy: China’s December producer and consumer inflation both came in below expectations. In Europe, disappointing German data held the euro, which remained flat against a falling dollar.

Heading up:

Cushions – credit sell-off increases margin for error: Despite the pain, at least the recent credit market sell-off has left investors with a bigger protective cushion before losing money: according to M&G fund manager Wolfgang Bauer, spreads of short-maturity, European Investment Grade corporate bonds would need to widen by 40 basis points (bps) this year before dragging investors into negative returns. This cushion, calculated as the index’s OAS/Libor spread divided by its spread duration, was below 10bps barely one year ago, a level which practically priced in perfection. As seen in the chart, the cushion has been growing as markets fell, especially following the Italian election in May, which raised fears about the future of the EU. This margin has now reached the highest level in about two years and is about four times bigger than a year ago. According to Wolfgang though, European corporate bonds are still sensitive to political volatility and to ample supply (usually a negative for bond prices). European data has also been disappointing, although economic growth is still expected to rise by 1.6% this year and by 1.5% in 2020 (down from 1.9% in 2018). Don’t miss Wolfgang’s credit review: Self-check: how did we do in our 2018 predictions?

US dollar and oil prices – perplexing the Fed: The strong correlation between oil prices and the US dollar over the past decade has surprised many investors – not least the Fed. In its recent blog “The perplexing co-movement of the dollar and oil prices,” the US central bank questions the logic behind the dollar’s weakness against the euro when oil prices rise. According to the bloggers, a 10% increase in oil prices is associated with a 1.5% depreciation of the dollar against the euro, something which not always makes sense as oil prices are often driven by Asian demand and Middle East output. Why would this affect the USD/Euro exchange rate? One explanation, the Fed argues, is that higher oil prices lower expected US output relative to Europe’s, dragging the greenback lower. This happens as Europe tends to tax gasoline more heavily, making European consumers less sensitive to petrol prices. However, the Fed admits it is hard to imagine that the levels of congestion on European roads do actually drive the USD/Euro exchange rate. The central bank leaves this issue as an open question – at the same time that oil prices are rising, and the dollar, falling.

Heading down:

US inflation expectations – Powelled: Fed chair Powell’s recent reassurance that the central bank remains data-dependent, watchful of market reactions and not blind to inflation’s failure to significantly pick up, threw a bucket of cold water over US inflation expectations. Also challenged by the recent drop in oil prices, the Fed’s favourite inflation expectations gauge – the five-year forward breakeven rate (blue line) – has plunged to 1.75%, the lowest level since June 2017. The figure is substantially below the country’s consumer inflation forecasts (dotted orange line), a mean average of multiple analysts’ quotes, currently expecting inflation to have reached 2.4% in 2018, slowing down to 2.2% in both 2019 and 2020. As seen in the chart, the increasing difference between the two magnitudes breaks a close correlation over the years: some observers say this is because analysts’ inflation forecasts are unrealistic, while others say that breakeven rates, or market expectations, are too pessimistic as the US economy is still expected to deliver economic growth of 2.6% this year and 1.9%, next. As ever, mis-pricing are what active investors look for – as long as they are right.

Germany – in recession? Ten-year German bund yields are trading again at 0.2%, having reached a 2-year low of 0.15% at the beginning of the year. This time, though, the yield drop may come for all the wrong reasons rather than because of safe-haven demand: industrial production fell for a third straight month in November, bringing the annualized figure to a negative 4.7%, the lowest since 2009, and raising concerns about Europe’s strongest economy slipping into recession. German industry has been hit, among other things, by reduced global trade and a slowdown in China – Chinese car sales fell by 6% in 2018.

The new year has started with a blunt reminder of probably everything that investors wanted to forget over the holiday season: economic data is worsening while the oil price continues to fall, dragging down equities and the most equity-like fixed income asset classes. Traditional safe-havens continue to rally, as they did in 2018.

The year left behind ended far worse than it started: after a strong-growth 2017, where most fixed income sectors delivered positive returns, last year’s early hopes quickly sank with the escalation of the US-China trade war and the Italian elections in May, which raised questions about the future of the European Union (EU). Fears of a hard Brexit also weighed on the continent’s economic prospects, lifting credit spreads above those in the US for the first time in years. China continued its slowdown, while in the US, optimism started to fade as interest rates rose, economic data disappointed and oil plunged to less than $50 per barrel amid forecasts of weak demand. US corporate earnings projections were also reduced as the effects of the recent tax cuts started to decline. The world benchmark US 10-year Treasury yield, which reached a 7-year high of 3.2% last year, changed gear after the Democrats won control of the House of Representatives in the November mid-term elections. Investors believed that their victory reduces the chances of further tax incentives from President Trump. The 10-yr Treasury yield has been on a continuous slide since, ending 2018 at 2.66%.

Despite the pessimism, almost one third of the 100 fixed income asset classes tracked by Panoramic Weekly delivered positive returns last year, led by traditional safe-havens, such as German bunds and US Treasuries. With global growth slowing down and global debt reaching a whopping 225% of world GDP, investors are betting some central banks may have to rein in their rate hike projections – offering more support to bond prices. US Federal Reserve Chairman Jerome Powell already did in December – the Fed now sees 2 rate hikes this year, instead of 3. The M&G Panoramic Weekly team wishes you a very happy new year.

Heading up:

Safe-havens – the best of times in the worst of times: US Treasuries, European government bonds and Japan’s sovereign debt did in 2018 what they usually do: deliver positive returns, rain or shine. While corporate debt markets and developing nations suffered from higher interest rates, a stronger dollar, the ongoing trade wars and lower global economic growth, traditional safe-havens remained solid. Treasuries have only posted negative returns in 2 of the past 18 years (2009 and 2013), while European and Japanese government bonds have only missed 1 year of positive returns (2006 and 2003, respectively), over the same period. Sovereign bonds have been favoured by protracted global low inflation, a backdrop that may continue going forward given the recent plunge in oil prices. Weaker growth and rising global debt may also refrain central banks from tighter monetary policies: out of 19 major economic areas, 5 are projecting lower rates in 3 years’ time (the US, Mexico, the Czech Republic, Japan and Korea), compared to none barely 2 months ago, according to Bloomberg data. In terms of currencies, safe-havens have also outperformed, mainly the US dollar and the yen. As Dickens would have put it, for safe-havens, it was (is?) the best of times, it was (is) the worst of times; it was the age of wisdom, it was the age of foolishness…

China government bonds and loose policy – odd one out: China’s USD-denominated sovereign debt returned 3.8% to investors in 2018, the third best performer among the 100 fixed income asset classes tracked by Panoramic Weekly. The rise comes despite a slowdown in economic growth, now down to an annualised pace of 6.5%, from 6.9% last year. The country’s manufacturing PMI dropped to 49.4 in December, the weakest since 2016 and below the 50 level that marks a contraction. Yet, the Chinese government’s stimulus policies, including cuts in the banks’ reserve requirements, continue to support the economy and the bond market. Still mostly in the hands of local investors, Chinese debt is increasingly available to foreign holders via the Bond Connect programme, and may be more in demand after it is included in some Bloomberg Barclays benchmark indices from April this year. In the present global rate rising environment, investors welcome a country with an overall easing policy.

Heading down:

Business cycle – down-sloping? With the last recession now a decade ago and economic theory suggesting that cycles tend to last about 10 years, investors are understandably concerned – hence their preference for safe-havens over risk assets. But more than timing, the nervousness comes amid other signals: during the late expansion phase of a business cycle, economic growth tends to be above the long-term trend growth, but the pace starts to slow down. In the US, for instance, growth is expected to drop to 2.6% this year, and to 1.9% in 2020, down from an expected 2.9% in 2018. This “late expansion” phase is also characterised by restrictive policies (which we are seeing around the world as central banks move from Quantitative Easing to Quantitative Tightening), and by rising inflation (in the US, inflation is expected to rise to 2.4% in 2018, up from 2.1% in 2017). Interest rates are usually higher (the 2-year Treasury yield, the de facto world’s discount rate, leapt from 1.8% to 2.49% in 2018), bringing volatility to equity prices (the S&P 500 index lost 6.2% last year). If this “late expansion” narrative applied well in 2018, the new year might bring us the following “slowdown” phase, where we usually see: slower growth (already forecasted), peaking consumer confidence (this is a lagging indicator as consumers typically need to see weak data before holding up purchases), a cooling off of restrictive policies (Fed chair Powell could have already signalled this in his dovish December speak), as well as higher inflation (also in the cards in the US). In this environment, long term bond yields usually drop as investors discount the slowdown, while equities suffer from the anticipation of a future recession, which would be the next stop. As usual, opinions vary: while the Fed sees 2 rate hikes next year, and further tightening in 2020, markets are pricing in no hikes at all this year, and cuts afterwards. Nobody knows what the future holds, but over the past few years, markets have been better predictors than then Fed.

EMs – tough year: Emerging Markets (EMs) USD-denominated sovereign debt fell 4.3% last year, the third annual loss over the past 18 years (the others being in 2013 and 2008). The period also includes ten years of double-digit positive returns, as the asset class benefited from strong global growth in the early 2000s, while remained relatively immune to the 2007-2008 financial crisis given its lower banking problems. But 2018 brought them a toxic mix of a rising dollar, falling oil prices (which hit oil-exporting EM heavyweights such as Brazil, Mexico and Russia), trade wars and idiosyncratic problems in Argentina and Turkey. All this hit African, Middle Eastern and Latin American countries the hardest, with Eastern Europe and Asia remaining more resilient. Some investors argue that the fate of EMs may change this year as the ‘twin deficits’ in the US may contain any dollar surge while global growth is forecast to stay positive, albeit unspectacular. Some also believe that with yields at 6.8%, the highest since 2009, risk might be compensated.

Month: January 2019

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