EM Fixed Income: Battle tested, but shields still up

Anezka Christovova (0:03)

Hello, and welcome to our At Any Rate Emerging Markets Focus Podcast, a place for us to discuss recent developments and key issues of focus in the emerging market fixed income as a class.

I'm Anezka Christovova, head of EMEA, EM, and LLATAM Welcome Market Strategy here at JPMorgan. And I'm joined by Ben Ramsey, head of EM Sovereign Preview Strategy, and Tania Escobedo, Senior LLATAM FX Strategist, both at JPMorgan. Ben, Tania, thanks for joining.

Tania Escobedo (0:29)

Thank you, Anezka.

Ben Ramsey (0:31)

Thanks, Anezka, nice to be here.

Anezka Christovova (0:33)

So we have all prices through the threshold of $100 per barrel.

US yields are reaching new year-to-day highs, and the FET is now clearly in play. Depending on the next CPI print, we are forecasting the FET to hike either in September or December. The base case is that US core CPI prints just a touch above 0.2 month-to-month tomorrow, which would be consistent with the December hike, but obviously here, a print slightly above, and we could be easily speaking about September, and obviously markets are repricing the probability as we speak. Now that has been a fairly challenging backdrop, but I guess that EM has actually not fared that badly. We have DXY down over 2% since the start of July, and EMFX is up about 2% in spot terms over the same period, and over 3.5% in total return terms. Our bonds have not performed well, but with the help of FX and higher yields, the GBI EM local markets index is up on the air.

So, yeah, in total, it's not been that bad. I would also mention that the numbers here that I just quoted, they, for instance, don't include Korean bond, which has seen very large FX gains in recent weeks. In EM and sovereign and corporate credit, we have held about flat over the summer and still up on the year in total return terms. So overall, EM has dealt with the external pressures reasonably well. In this podcast, we will review whether EM can still perform into the final quarter of the year. And we will also focus on the various more idiosyncratic stories.

Ben Ramsey (2:35)

So, Anezka, let me turn that back to you.

EM local markets have been overall resilient, but as you said, mainly thanks to FX, would you say that these trends can persist? Or rather, is that our performance we've seen over the summer, does that make local markets a little bit more vulnerable to a correction?

Anezka Christovova (2:56)

Right, so let me set the scene a little more, a bit more detail on EMFX. So I think it is actually quite remarkable that over the past month in total return terms, only two currencies have delivered negative returns, Chilean peso and Philippine peso. Even over the past five days, when these pressures have accelerated, we have a good third to half of the space delivering positively, which is really remarkable. Now, in the short term, I would say there are certainly risks. The repricing of rates is getting to a point where we could see EMFX take a bit more notice. So let me break that down. I think what matters is both the jump in yields as well as the volatility of them all. When we think about the repricing of the FED, it's been quite sharp. On the day, we are speaking here over 10 basis points for FED, how much is priced for the FED hikes.

As a rule of thumb, for the level of yields, the lower yielders are more sensitive. So in each region, we have some more vulnerable currencies to the outright level of yields for the US. So let's say in Lhasa, there will be Chilean Peso as the lower yielder. In EMEA, EM, it will be Shekul, where the central bank is still cutting. Obviously, some lower yielding parts of Asia are also vulnerable. Now, then there's the second point, which is the volatility of the move. The volatility of the move is a lot more important for carry strategies. It's actually quite interesting that the repricing of rates globally has not been particularly volatile. Measures of rates volatility are quite low, and that has kept carry perform in EM. We can see bouts of little volatility when the moves happen a bit faster, when EM carry takes a notice. But probably speaking, the repricing has not been particularly volatile. But to sum it up, in the short term, we could see some issues with the repricing of rates, especially in the US. However, what we have been emphasizing, and I think it remains important, is that the repricing is quite synchronized globally because it's driven by a synchronized global cyclical uplift and synchronized global inflationary pressures. I think for the FX market, which is a relative asset class, that that makes the most difference. I think that's why ultimately EMFX, it will obviously react to the points of fast repricing. But structure, it's, I think, in a good place for as long as the cyclical outlook remains supportive. I would also say that we continue to see on our matrix, relatively moderate positioning, in some cases even low positioning. There are a few pockets of higher positioning, which is in frontiers and the very high yielders, Lira Brazil. But actually in most currencies, the positioning scores are quite moderate to low and even very low, for instance, in the case of Asia.