Year-to-date EM high yield (HY) corporate bonds continued to show their resilience, despite the fact that expectations of monetary tightening continued to weigh over investor’s sentiment. Is it the greed of investors holding tight to their high coupon bonds? Or are there other elements which market participants are envisaging going forward?

To date heading the list of gainers are once again Emerging market hard currency bonds which continued to maintain their upside momentum, despite the huge skepticism of their performance vis-à-vis a stronger dollar. For clarities sake, the said asset class is up 3.5 per cent, with the interesting bit being that 1.86 per cent from the total 3.5 per cent are price returns and the remainder is income return. European high yield registered total return gains of 1.66 per cent with the discrepancy being justified by the very tight yields which are unattractive in terms of risk-adjusted returns.

Theoretically speaking the so-called ‘coupon effect’ is one of the reasons why high-yield bonds tend to be less sensitive to interest rate movements. In fact, the high coupon being paid by the company mitigates the impact of the movement in interest rates (if one had to exclude in his assumptions other issues).

However, imperatively apart from the theoretical perspective, market participants do consider the current market conditions. In fact, interestingly enough in my view, another reason for the discrepancy in performance between EM hard currency bonds and European HY is the lack of yield in the latter. This fact was also witnessed in 2016, prior to the U.S. election, when EM registered notable capital inflows.

The other interesting fact was the correction in EM bonds following Trump’s election. In terms of numbers, the correction was of 2.5 percent, thus not considered as harsh as investors’ anticipated. In actual fact the major correction was in Mexico bonds which plunged remarkably due to Trump’s chatter in regard Mexico.

Skepticism on EM exposure is still high amongst market participants, however my take is more at the trading range of the USD against major EM currencies. In my view, if the dollar maintains the range experienced after Trump’s election, EM names should continue to perform well. For instance, in November USD/BRL traded at highs of 3.43 and now to lows of 3.06, which in turn ticked Brazilian hard currency names. My concern would be a dollar which breaches the November levels. In that case we should experience a deterioration in EM bonds. My rationale is based on high probabilities that the market has now priced in the said FX movement range.

As I have opined in other articles, going forward being selective is crucial in order to beef up your yield at acceptable risk-adjusted levels. However, let’s not underestimate the possible nasty surprises by Trump’s administration, mainly not the promised fiscal expansion, but more his way of thinking under his political mandate.

This article was issued by Jordan Portelli, Investment Manager at Calamatta Cuschieri. For more information visit, www.cc.com.mt .The information, views and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice. Calamatta Cuschieri Investment Services Ltd has not verified and consequently neither warrants the accuracy nor the veracity of any information, views or opinions appearing on this website.

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