The theme of relative calm and improving investor sentiment continued in October. It was a strong month for emerging market currencies and this boosted local currency bond returns (close to 3% up on September). Hard currency sovereign (+0.3%) and corporate bond markets (+0.9%) also rose, all in US dollar terms.
A variety of factors created a more positive backdrop
A variety of factors created a more positive backdrop for investment markets. These included:
- Encouraging progress towards ‘phase one’ of a US/China trade deal
- Signs of global economic growth stabilising
- Improving prospects of a Brexit deal
- The shift towards monetary-policy easing by key central banks, including the US Federal Reserve.
Ukraine’s central bank was among those delivering a bigger-than-expected cut. While in Russia the combination of lower-than-expected inflation and a dovish central bank raised the prospect of rate cuts and caused a bond-market rally.
Turkey’s military incursion into Northern Syria marked a worrying step, as we wrote here. While a ceasefire agreement and reduced risk of sanctions later brought a degree of calm, uncertainties remain. Turkey's central bank made another aggressive interest rate cut as inflation figures were lower than expected.
Argentina went to the polls again and voted in the left of centre presidential candidate Alberto Fernandez. Please visit Emerging Perspectives for further comments.
Also in Latin America, Brazil released stronger-than-expected economic data and saw demand for its relatively high-yielding currency boosted, thanks to the broad improvement in investors’ risk appetite.
Top down views and outlook
The positive developments mentioned in our Market review on trade, growth and monetary policy direction prompted us to increase our overall risk exposure in early October, moving to an overweight stance.
We turned more constructive on emerging market currencies, while we continue to hold our positive view on high-yield hard currency bonds. There are still risks linked to trade war uncertainties and the potential for a sharper-than-expected downturn in US economic activity, but overall we are comfortable with a modest overweight position across our strategies.
The recent resumption of the US Federal Reserve’s purchases of US Treasury bills is one factor behind our decision to increase our exposure to emerging market currencies. We expect the continued backdrop of low rates to boost emerging market currency strength by attracting investors to the higher yields they offer relative to many other markets. We also believe the trajectory for relative economic growth – with emerging market economies having relatively more room and potential to surprise on the upside than their developed market peers – will support the asset class.
We maintain our overweight stance in hard currency bonds, as mentioned above. There we still see some value, given improving credit fundamentals overall and particularly in non-oil exporting, high-yield reform stories. We are also encouraged by a recent shift within the IMF to a more holistic approach to economic reform, in light of some recent negative headlines which underlined the risks associated with unpopular fiscal austerity policies.
We remain neutrally positioned in local currency bonds, where the risks seem quite balanced: local-yield valuations look quite stretched, although the soft growth and inflation environment provides ample scope for further easing by emerging market central banks.
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