Year-to-date EM high yield (HY) corporate bonds continued to show their resilience, despite the fact that expectations of monetary tightening continued to increase with the market now pricing a 100 percent June hike. 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 scepticism of their performance vis-à-vis a stronger dollar. For clarities sake, the said asset class is up 5.5 per cent, with the interesting bit being that the majority of returns are being generated from price returns.
Theoretically speaking the so-called ‘coupon effect’, a market antidote of how it tends to react, 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.
Scepticism 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 post-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.
Undoubtedly, a very strong dollar would impact negatively exports which as at the end of March stood at $190.99 billion. Clearly, a sustainable range will have to be maintained. Surprisingly, such comments were also recently tweeted by President Trump.
As I have opined in other articles, those investors which are dependent on income will continue to search for yield. In this regard being selective through a well-diversified portfolio is crucial for both the capturing of returns but also to mitigate risk. Keep in mind that fundamentally EM economies are much better positioned than developed economies. Be rationale and you will succeed.
Disclaimer: 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.