Global Viewpoints: Sovereign Debt - U.S. Dollar Rally Drives Global Risk, Puts Pressure On Emerging Markets

by: Janus Henderson Investors

By Ryan Myerberg

In the third of a four-part series, Portfolio Manager Ryan Myerberg looks at the impact that a fluctuating U.S. dollar has on emerging market debt.

Despite stronger sensitivity to movement in the U.S. dollar and other challenges within emerging markets, we still think there are opportunities for long-term investments in countries where we're seeing fundamental improvements and stable politics.

Key Takeaways

  • A U.S. dollar rally since the beginning of the second quarter of 2018 has put pressure on emerging markets, impacting positions in all fixed income portfolios.

  • Countries such as Thailand, Colombia and Chile - which have worked hard to reduce deficits, create surpluses and embrace fiscally prudent policies - offer opportunities for fixed income investors with a long-term view.

  • In the final part of the series, Myerberg will discuss where value can be found in global sovereign debt markets.

View Transcript

Myerberg: The biggest driver of risk in today's global market is the offer opportunities for fixed income investors with a long-term view.U.S. dollar. What we saw at the beginning of the year when the dollar was under a lot of pressure was driven by two things. One was the market had sort of priced in their expectations for the Fed. They said, "This is the Fed's ability to continue to hike rates. We think it's fully priced in and we think other central banks like the ECB, the Bank of Japan, the BOE, for example, will be able to move towards a more, a tighter monetary policy stance. And ultimately, that should strengthen their currencies with relation to the U.S. dollar. What we've found in the subsequent months - sort of March, April, May - is that global growth has turned over to some extent. Europe has come off the boil and has slowed down their issues in Japan with growth or issues in the U.K. with growth. And so, those expectations for other central banks to move towards the Fed with regards to hawkish monetary policy have diminished, while the Fed and the underlying U.S. economy continues to just go gangbusters. So that's caused the dollar to rally, and that dollar rally puts pressure on risk assets. It puts pressure on EM, especially, where even positive fundamentals in EM are being offset by the idea that U.S. real rates are moving higher, that the dollar is moving stronger, and so the dollar is, at the moment, the biggest driver of global risk.

Typically when you see big moves in the U.S. dollar, either up or down, it has a direct impact to emerging markets. Emerging markets have to fund themselves two ways: You can fund yourself issuing local debt, the home currency your country, or you can fund yourself externally, so issuing debt in U.S. dollars. And so you tend to see because of that reliance on external funding and how correlated to the dollar these countries are, those risk markets move up and down depending on how the dollar performs. And so what we're seeing today is because of this strength in U.S. dollars, it's putting a lot of pressure on emerging markets, which is a bit challenging as an investor because if you think about past cycles where the dollar has rallied, emerging markets weren't in the same place as they are today with regards to current account deficits or surpluses. Emerging markets have done a lot of heavy lifting to make their economies more competitive, less reliant on external funding, so compressing those current account deficits, becoming surplus countries. But what we're finding today is because of how wildly the risk markets are, it's like good countries with current account surpluses, for example, or stable fiscal positions, are still being treated the same as countries who are in the opposite camp. So you obviously have the idiosyncratic stories like Argentina, like Turkey, like South Africa, that have some challenges and certainly you've seen the Argentine peso move materially higher, Turkish lire and Turkish bond yields move higher because of the issue they have in country. But even countries, say, like Thailand that run current account surpluses of north of 8%, 10%, are still struggling.

So while emerging markets are challenged today, undeniably, we still think there are opportunities to invest in countries where things are improving. One of the countries that we really like is Colombia, for example. One, we believe the global growth picture is not as bad perhaps as sentiment would tell you today. So improving growth means more demands for commodities. We expect oil to move higher, and the Colombian peso is very correlated to oil prices. Secondly, we've seen improvement in the political backdrop. We have a center right candidate in office today who should be very market friendly, fiscally focused. So, the economic backdrop, the fiscal backdrop, we expect to improve. So that's the kind of fundamental story to focus on in emerging markets - when risk markets stabilize and we should see EM come back to the forefront. We like countries like Chile for similar reasons: global demand for copper tends to drive the Chilean peso higher. They also have improving fundamentals as well as stable politics. You can look at those two countries versus countries like Brazil with political issues, Argentina with currency issues. We also like Asian countries like Thailand who benefit from China's growth picture, who benefit from really strong account surplus and fiscal dynamics. We expect to see currency appreciation over time.

You want to identify countries and opportunities that you believe should outperform over time. But the asset class tends to trade as one, so good countries and bad countries tend to trade up and trade down together.

Disclaimer: Foreign securities, including sovereign debt, are subject to additional risks including currency fluctuations, political and economic uncertainty, increased volatility, lower liquidity and differing financial and information reporting standards, all of which are magnified in emerging markets.

Fixed income securities are subject to interest rate, inflation, credit and default risk. The bond market is volatile. As interest rates rise, bond prices usually fall, and vice versa. The return of principal is not guaranteed, and prices may decline if an issuer fails to make timely payments or its credit strength weakens.

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