Weekly Bond Bulletin

19 November 2020

A shot in the arm for EMFX

With positive vaccine developments presenting an eventual pathway out of Covid-19 restrictions, fixed income investors may find value in emerging market currencies (EMFX).

Fundamentals

Recent vaccine developments have boosted markets and allowed investors a glimpse of a post-pandemic society. Despite near-term concerns around rising case counts in some countries, risk sentiment should be robust over the medium to longer term, with spread products benefiting. Success on other vaccines could be particularly supportive for emerging markets: the AstraZeneca vaccine is expected to be distributed more widely across the globe, with many more pre-orders taken from emerging market (EM) countries than has been the case with other vaccines. If the AstraZeneca vaccine is effective, emerging markets stand to benefit, since they have hitherto been more vulnerable from a public health standpoint, and certain EM economies (such as Thailand, Peru and South Africa) are sensitive to travel and tourism activity. Stronger global growth should also lead to a pick-up in global trade and be supportive for commodity prices. The other key fundamental support for emerging markets is central bank policy, which is keeping core rates anchored, and EM central banks remain consistent with their developed market counterparts in their easy policy stance.

Quantitative valuations

One potential valuation opportunity within the emerging market complex is EMFX, which looks very cheap relative to the performance of other sectors since March. Equities, developed market credit and hard currency emerging market debt are all back in positive territory. Emerging market local currency bonds are down 0.77% on a total return basis, but the carry and price return on the bonds has been strong at 6.83%: the FX component, down 7.16%, has entirely driven the overall negative return. Selectivity is crucial given the differentiation in the index, but EMFX could present an opportunity, especially given the yield enhancement on offer relative to developed markets.

EM currencies have substantially lagged the risk recovery

Source: Bloomberg; data as of 18 November 2020. IG=investment grade.

Technicals

Almost USD 750 million has flowed into EM local currency funds so far in November. We have also recently observed, through investor surveys, a significant shift upwards in EMFX positioning across both emerging market debt and equity, suggesting robust demand for the asset class more broadly. As a note of caution, it’s important to watch for signs that EMFX isn’t becoming overbought, but nevertheless, key supportive technical factors persist. The global grab for yield has not gone away, with a huge amount of assets still sitting in money market funds (currently standing at USD 4.3 trillion, compared to USD 3.6 trillion at the start of 2020). In addition, we believe there could be crossover investors—such as those managing unconstrained and multi-asset strategies—with more room to add to their EM allocations.

What does this mean for fixed income investors?

As progress is made towards multiple vaccines, lifting hopes that travel and tourism can return to become a feature of normal life, EM economies should benefit. For investors on the lookout for pockets of value, EMFX could present an area to focus their search. With current demand dynamics fairly strong, and an ever-present technical tailwind from the global hunt for yield, 2020’s laggard could look interesting going into 2021.

About the Bond Bulletin

Each week J.P. Morgan Asset Management’s Global Fixed Income, Currency and Commodities group reviews key issues for bond investors through the lens of its common Fundamental, Quantitative Valuation and Technical (FQT) research framework.

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19 November 2020
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