PI Partnership – Eaton Vance
Matthew Murphy is a senior institutional portfolio manager in the global income team at Eaton Vance
OUTLOOK BRIGHTENING FOR EMERGING MARKETS CURRENCIES
March marks one year since financial markets witnessed an unprecedented level of volatility and tumult. UK institu- tional investors are well aware of this milestone as well as the tremendous resurgence in global capital markets over the ensuing period, fuelled largely by monetary and fiscal stimulus. Value opportunities, where they exist, have become more difficult to find, with few sectors able to claim attractive valuations. Consider, too, that the realisation of potential upside requires one or more catalysts. With these factors in mind, we think that emerg- ing markets local currency (EM FX) is a key area that merits investor attention based on the fundamentals, macro environment and technical support for the sector. Here are the key reasons why: – Relative value. EM FX lagged most risk assets during the rebound. Last year, the FX component of the JP Morgan Govern- ment Bond Index-Emerging Markets (GBI-EM) Global Diversified, a primary benchmark for local currency EM debt, was down over 7% in USD terms. Even as recently as November, many EM curren- cies were still trading at 2020 lows.
– Fundamentals. EM growth is leading the global economic recovery. Crucially, EM lock downs were not as severe in the ini- tial response phase to Covid-19, and they are not restricting business activity as aggressively now with additional waves, either. Global trade and EM exports have recovered to “pre-Covid” levels. In addi- tion, the rallies in prices for oil and com- modities more broadly have improved the economic dynamics for many EM countries. – Macro environment. Developed-market monetary policies should continue to anchor core interest rates at extremely low levels, which includes $18trn (£12.8trn) of negative-yielding debt. Combined with massive fiscal stimulus in many coun- tries, the global economy is likely to re- main awash in liquidity. Furthermore, when US deficits balloon, as they have re- cently, historically that has resulted in a weaker US dollar. The chart below shows the relationship between the twin US defi- cits (budget and trade) with the US dollar. The USD line is lagged by a year to high- light how the path of the deficits has often been a predictor for the path of the US dol- lar. If previous patterns hold, the sharp in- crease in the deficits could indicate fur- ther sharp erosion of USD strength.
100 120 140 160
20 40 60 80
0
1992 1994 1995 1997 1999 2001 2003 2005 2006 2008 2010 2012 2014 2016 2017 2019 DXY - Lagged 1 Year (LHS
US Twin Deficit as %/GDP (RHS)
Source: IMF, Macrobond, Eaton Vance. As at 1 September 2020 (for twin deficit data) and 1 December 2020 (for US dollar index data).
Sources of data: Eaton Vance, JPMorgan, IMF, Macrobond. Data is as at 31/12/2020, unless otherwise specified. This material is presented for informational and illustrative purposes only. It should not be construed as invest- ment advice, or to adopt any particular investment strategy. Investment views, opinions, and/or analysis ex- pressed constitute judgments as of the date of this material and are subject to change at any time without notice. This material is for the benefit of persons whom Eaton Vance reasonably believes it is permitted to communicate to and should not be shared with any other person without the consent of Eaton Vance. Outside of the EU and US, this is issued by Eaton Vance Management (International) Limited (“EVMI”), 125 Old Broad Street, London, EC2N 1AR, UK, and is authorised and regulated by the Financial Conduct Authority. In emerging market countries, the risks may be more significant in regards to sensitivity to stock market volatility, adverse market, economic, political, regulatory, geopolitical and other conditions. For Professional Clients/Accredited Investors only.
Issue 100 | February 2021 | portfolio institutional | 47
– Technicals. Investors have been allocat- ing to EM debt, including crossover buy- ers seeking to avoid the ultra-low yields available in other sectors. We believe, however, that this trend has plenty of steam left, given that cashflow into the sector did not turn positive until the end of last year. Until that inflection point, fol- lowing the start of the pandemic in March 2020, outflows from the sector were the largest on record. Positive flows into the sector are likely to help EM countries struggling with the effects of Covid-19, which continues to wreak havoc on lives and livelihoods. EM countries vary widely in their ability to navigate the associated economic chal- lenges, with a growing roster of defaults and debt restructurings making selection critical. Notwithstanding these difficul- ties, we remain broadly constructive on the space.
In conclusion, emerging markets local currencies are likely to be a powerful fac- tor driving EM debt returns this year. With proper expertise, due diligence and atten- tion to country-specific risk, we believe that investors who allocate to EM debt will be better positioned to capture one of the few value opportunities that appears to be so elusive in other sectors today.
US “twin deficits” appear to be signalling a weaker US dollar
-35 -30 -25 -20 -15 -10 -5 0 5
US Twin Deficit as % of GDP
US dollar index (DXY)
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