EM Fixed Income: Enduring the heat, trying not to get burned

Ben Ramsey (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 asset class.

I'm Ben Ramsey, Head of EM Sovereign Credit Strategy here at JPMorgan, and I'm joined by Anezka Christovova, Head of EMEA, EM, and Latam Local Market Strategy, and Mike Harrison, Senior EMEA, EM Local Market Strategist, both at JPMorgan. Anezka, Mike, thanks for joining.

Anezka Christovova (0:30)

Hi, Ben. Nice to be here.

Michael Harrison (0:32)

Hi, guys. Pleasure as always.

Ben Ramsey (0:35)

This has been a pretty tough few weeks for EM markets, really for macro markets as we move from September into October. I think the core market drivers that are underpinning this current pressure remain the same and remain frustratingly unresolved. We continue to see oil markets, energy markets trading at very high levels, a little bit of hope of relief that we saw maybe a week or so ago, frustrated again, crude oil back above 100 We continue to see core rates markets pressing higher.

We thought we saw a really sharp move, or we didn't see a really sharp move in terms of the US treasury market. In September, we thought maybe with the Fed hike, that would slowly arrest that and we could have some stability. But in fact, we've just seen that the 10-year continued to move higher. And given that we kind of have underlying fiscal pressure in the US and the EM, and we have importantly really strong growth that we're observing, continue to revise up our growth forecast, now seeing PMIs, which look like this has got more to run in terms of economic resilience. And these pressures on inflation and worries about inflation expectations are just kind of hard to see what's going to arrest this upward movement in treasuries. And the Fed is now in a trickier position in terms of how it's going to deal with these pressures in a world where they're changing kind of their framework and their framework on forward guidance. So we're in this resilient global growth, firmer inflation world. EM is kind of taking it on the chin in terms of this is played into a stronger dollar, obviously putting pressure on rates. We finally see some pressure on credit spreads, even though we remain, I would say, at pretty tight levels overall. So this is the backdrop. And I think we can argue that EM is held in pretty well, but still is facing this pressure.

Let me open it up now. That's how I would paint the picture. But let me turn over to you, Anezka.

What do you think is sort of best explaining the pressures we're seeing specifically on EMFX in this global context? And of course, if you would characterize any of those things a little bit differently, let us know. But the sell-off that we've seen in terms of EMFX, is that changing our conviction at all in the ASTEC classes as we go forward?

Anezka Christovova (3:04)

Right. So let me just first characterize the sell-off that we've seen in EMFX.

So the sharper part of the sell-off started in the first few days of September, let's say 9th of September, we cut off. I found it quite interesting that we found that the best exploratory factor in terms of positioning for that sell-off wasn't actually any of the FX positioning indicators, but rather bond positioning indicators. We actually get the largest R-squared on the scale of individual currencies, how much downside they've seen based on the bond positioning. So it looks initially the trigger here was a little bit of a bar shock from the sell-offs in rates markets. We've then also seen implied volatility rise for EMFX, which put further pressure on some of the highest carry plays, which obviously are the most positioned ones. Finally, I would also say that energy markets played some role.

We would find that actually the full energy exposures are not a good explanatory factor for the sell-off. But if we dig deeper and look at actually countries with the largest product exposures, such as diesel or gas price exposures, those have seen relatively larger sell-offs. So I think for the start of trying to explain the price action, rates of our shock, higher volatility and some energy exposure certainly played a part. But I would say since then, the discussion has now become a little bit more involved. What we think is entering the picture is a little bit more macro uncertainty. So as you mentioned, the growth outlook has been strong, certainly resilient. But I think that we are starting to notice a little bit more discussions of whether that is indeed going to be the case going forward, or at least the degree to which that persists. Because the core pressure has indeed been significant, energy pressures have been significant. Now I think we are finally seeing some fall through, for instance, the fiscal risks. Some central banks such as ECB are telling us that the monetary policy tightening might already have some growth effects, and they might not have to tighten as much or as fast. So we are starting to see some of the growth distribution, I think, being impacted, and that is certainly working its way also to the EMFX market. So where does it leave us?