By Natalia Gurushina
Chief Economist, Emerging Markets Fixed Income Strategy
Van Eck Associates Corporation
All eyes are on the U.S. Federal Reserve (Fed) today, and with rate hikes widely expected at some point in 2022 (around June, according to Fed Funds Futures), the question is what it means for risky assets, including emerging markets (EM). Past experience shows that EM bonds did quite well during the past two Fed hiking cycles – so, can we sit down and relax? There are three counter-arguments suggesting that investors might need to adopt a more selective approach this time around. First, U.S. rates are currently much lower than at the onset of the previous hiking cycles, which means that we are potentially facing larger dents in EM total returns due to higher “risk-free” rates.
Second, EM growth outlook is not as optimistic as before – the EM-U.S. real growth differential (ex-China) is expected to slip below 1% in 2021/22, and China’s real GDP growth is expected to be closer to the 5% handle in 2022 than to 7% at the beginning of the Fed’s last tightening cycle. These are the reasons why the market is fixated on supply chain disruptions, high input prices (commodities), various COVID strains and, of course, the policy direction in EM. China is one of the very few EMs that stepped up policy stimulus, and the latest domestic activity indicators suggest that more targeted support might be needed going forward. Industrial production bounced a bit more than expected in November (3.8% year-on-year), but both retail sales and fixed assets investments undershot consensus, underpinning the pessimistic 3.11% year-on-year GDP forecast for Q4.
Finally, spread compression accounted for a very big portion of EM bond indices total returns (both in High Yield and Investment Grade) in the past two Fed hiking cycles (see chart below), but some EM spreads look tight right now. For example, the Investment Grade sovereign spread (J.P. Morgan EMBIG IG Index) is close to the multi-year lows (see chart below). The same applies to both High Yield and Investment Grade corporate spreads (J.P. Morgan CEMBI Index, the chart can be provided on demand). So, stay tuned for the new EM Debt Monthly Report, in which Portfolio Manager Eric Fine talks about a “new state of nature”, where selectivity is key.
Chart at a Glance: EMBIG Spreads and U.S. Federal Reserve Target Rate
Source: Bloomberg LP
JPMorgan EMBI Global Diversified Index is an unmanaged, market-capitalization weighted, total-return index tracking the traded market for U.S.-dollar-denominated Brady bonds, Eurobonds, traded loans, and local market debt instruments issued by sovereign and quasi-sovereign entities.
The J.P. Morgan CEMBI Broad Diversified Core Index (CEMBI CORE) tracks the performance of U.S. dollar-denominated bonds issued by emerging market corporate entities.
Originally published by VanEck on December 15, 2021.
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PMI – Purchasing Managers’ Index: economic indicators derived from monthly surveys of private sector companies. A reading above 50 indicates expansion, and a reading below 50 indicates contraction; ISM – Institute for Supply Management PMI: ISM releases an index based on more than 400 purchasing and supply managers surveys; both in the manufacturing and non-manufacturing industries; CPI – Consumer Price Index: an index of the variation in prices paid by typical consumers for retail goods and other items; PPI – Producer Price Index: a family of indexes that measures the average change in selling prices received by domestic producers of goods and services over time; PCE inflation – Personal Consumption Expenditures Price Index: one measure of U.S. inflation, tracking the change in prices of goods and services purchased by consumers throughout the economy; MSCI – Morgan Stanley Capital International: an American provider of equity, fixed income, hedge fund stock market indexes, and equity portfolio analysis tools; VIX – CBOE Volatility Index: an index created by the Chicago Board Options Exchange (CBOE), which shows the market’s expectation of 30-day volatility. It is constructed using the implied volatilities on S&P 500 index options.; GBI-EM – JP Morgan’s Government Bond Index – Emerging Markets: comprehensive emerging market debt benchmarks that track local currency bonds issued by Emerging market governments; EMBI – JP Morgan’s Emerging Market Bond Index: JP Morgan’s index of dollar-denominated sovereign bonds issued by a selection of emerging market countries; EMBIG – JP Morgan’s Emerging Market Bond Index Global: tracks total returns for traded external debt instruments in emerging markets.
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