Traditionally, every time 10Y US Treasury Yields have jumped solidly above the 3% level - as they have in recent days - Emerging Markets were among the first casualties. But not this time, in fact quite the opposite as developing-nation stocks climbed for the fifth time in six days and the lira and rand led a rally in currencies.
Average spreads on emerging-market dollar and local currency bonds narrowed too. As the chart below shows, the largest ETF tracking emerging-market local currency bonds - the $6.1 billion JP Morgan JEML ETF - saw $169 million in inflows, the most since June 2017, after losing about a quarter of total assets since early April according to Bloomberg.
The inflows suggest that developing markets may finally be turning the corner after the worst slide in EMs since the financial crisis, as a result of a stronger dollar and global trade war.
Bizarrely, the rebound in sentiment has taken place against a backdrop of deteriorating China-U.S. trade tensions, and may encourage those seeing an end to a sell-off that’s hammered asset prices from Indonesia to Turkey and Argentina during a tumultuous past five months. The EM price gains have also given strength to the bout of optimism triggered last week by interest-rate decisions in Turkey and Russia that were more hawkish than many anticipated.
EM optimism appears to be contagious among analysts: quoted by Bloomberg, Bernd Berg, a strategist at Woodman Asset Management in Zug, Switzerland said that "currencies have found a bottom for now and the tactical rally might have some room to extend further as emerging-market central banks have come to the rescue with rate hikes,” said "Overall fundamentals are still solid and valuations are cheap in some emerging-market foreign exchange after the aggressive repricing this summer."
Franklin Templeton’s Chris Siniakov and Goldman Sachs Asset Management’s Philip Moffitt are among those who also say the declines in emerging markets are starting to ease.
The world's largest asset manager, BlackRock also said this week that emerging-market debt offers a “very good entry point” for investors, citing a tentative peak in the greenback and easing idiosyncratic risks.
The shift in mood has certainly spooked the EM shorts, who have materially covered their positions, a clear sign that the pessimism in emerging markets is starting to wane.
Furthermore, the correlation between emerging-market bonds and Treasuries is at the lowest in two years, which explains why U.S. yields above 3% aren’t an obstacle - for now - to developing-nation foreign debt as long as the dollar stays in check.
According to Bloomberg, the declining influence of Treasury yields may suggest that emerging markets are adjusting to the end of easy money and are focusing on threats to global trade as the main risk. Investors, however, who have been badly burned on the asset class, will be looking for more signs that the dollar has peaked before diving deep into valuations they maintain are too cheap to ignore.
Indeed, one reason why higher yields are being ignored may be that the strong dollar - which traditionally rises alongside yields, and is seen as an even greater nemesis to emerging markets - has slumped to the lowest level since the end of August.
Not everyone is bullish though: State Street is among those betting that the bearish trend has room to run. The firm is “pretty cautious” on emerging markets in the short term because of trade tensions, said Lori Heinel, deputy global chief investment officer.
But SocGen's FX veteran Kit Juckes best summarized the renewed general apathy to all market risks: "Where we are today, is in a period of relative calm as U.S. bond yields probe their highs, and we become accustomed to trade rhetoric and perhaps, blasé about the economic damage it will cause."