Antoine Lesné, Head of SPDR ETF Strategy & Research EMEA, has commented on emerging market EM debt and the hunt for yield.
He writes that after the cold showers from the July 2015’s Greek tragedy, the People’s Bank of China surprised the markets in August by suddenly devaluing their currency overnight. “This was enough to send markets into a tailspin. As expected, fears of a more abrupt Chinese slowdown triggered an outflow from Emerging Markets.”
However, one year on, the negative interest rate policy setting has been pushing investors back into the hunt for yield in the EM bond world, Lesné writes. “Somewhat dovish Fed minutes could give EMD assets a boost and as we head into the Jackson Hole meeting at the end of the week, any dovishness may foster further opportunities for EM bonds.”
Lesné gives five reasons why EM Debt still makes sense in the current environment, opening with a macro comment that activity is rebounding from depressed levels. “After a prolonged downturn during most of last year, Emerging Markets Manufacturing PMIs have been recovering of late,” he writes.
In terms of income, Lesné says that emerging markets’ yield is real. “Comparing developed and EM inflation-linked universes, it’s clear that the real yield differential remains advantageous. Nominal yield differentials would show a similar pattern, too. Adjusting for inflation always gives an interesting picture; and the yield allure of EM inflation-linked bonds is also generous.”
Monetary policy is loosening, Lesné says as a number of EM central banks have been taking an easing stance. “Earlier this year — after a bout of currency weakness pushed up inflation — some central banks also pushed up rates. However, now forex volatility and lower inflationary pressure have allowed EM central banks to engage in easing policies.
“The earlier tightening bias was more pronounced in commodity-producing countries. Among the largest countries in EM local currency indices, Mexico hiked by 50bps since last May. Meanwhile Turkey and Russia actually eased over the past three months by 0.75–1 per cent. The Central Bank of Turkey is expected to announce its policy rate on Tuesday, 23 August and may well be under political pressure to adopt a further accommodative stance.”
In terms of currencies, Lesné believes that they are driving performance. “EM currencies have rallied back against a backdrop of stabilising commodity prices and the delayed timetable for Fed rate hikes. It is worth noting that the Turkish lira has come back strongly this month, however it is also worth highlighting that there are potential rating agencies downgrades being awaited and may halt this recovery,” Lesné writes.
Finally, Lesné writes that investor flows into ETFs have continued to recover with no holiday for EMD ETFs. He writes: “After the China-induced weakness last year and the challenging start of the year, international investor flows into emerging markets have come back en masse. Nevertheless, a pause occurred ahead of the Brexit vote, highlighting the overall uncertain environment we currently operate in. However, data in June and July may have signalled that the time is right to go back to the emerging world and USD5.7 billion has flowed into EMEA-domiciled EM debt ETFs year-to-date.”
Meanwhile, he also notes that flows into EM debt ETFs have shown some resilience over the past 12 months. “While outflows were pronounced in the second part of 2015, following fears about China, ETF investors have shown resilience in the early part of 2016. The very accommodative stance of developed central banks and the ECB announcements in March have re-ignited the search for yield. Emerging Market Debt became the natural place to hunt yield. Even the 15 July coup in Turkey barely disrupted this trend.
“Overall, China remains a potential dampener of appetites, but the danger has not awakened yet and there is currently little reason for the tide to turn in the weeks ahead. Nevertheless, this week’s speech by Fed Chair Yellen at Jackson Hole may prompt a degree of caution, depending on whether she sounds more hawkish than current expectations.”
Lesné concludes that a more hawkish Fed could trigger a pause in performance by strengthening the US dollar. “However as the case for lower for longer remains this could actually give rise to further entry points.”