FIXED INCOME STRATEGY

Emerging market pause

Feb 21, 2017 / By Jeffrey Rosenberg

Rich valuations and U.S. policy risks call for a pause on emerging market (EM) debt in the short run. We also detail why we believe mortgage-backed securities deserve a fresh look.

Fixed income highlights

  • The rally in EM debt has pushed spreads to levels that we believe merit a neutral stance in the short term – especially considering U.S. policy uncertainty.
  • Global reflation supports the long-run EM debt outlook. Yet a rising dollar and threats to trade are challenges. We favor hard-currency over local-currency debt.
  • We raised our view on agency mortgage-backed securities after valuations fell. We stay neutral for now on concerns over the timing of Fed rate increases and any moves to unwind its balance sheet.

Snapshot

The EM advance this year has compressed EM hard-currency spreads versus U.S. Treasuries to where they were before the post-U.S. election rout. In other words, EM Dent prices have made a round trip. See the chart below.

Fading Trump effect
EM hard-currency spread, 2016-2017

Source: BlackRock Investment Institute, Bloomberg and J.P. Morgan, February 2017.
Note: The spread measures the yield differential between the J.P. Morgan Emerging Market Bond Index and U.S. Treasuries.

The biggest trigger of the rally was a sobering reassessment of the likelihood and timing of U.S. stimulus under the incoming President Donald Trump. This helped push down U.S. interest rates and stopped short a dollar rally that had weighed on EM assets. A powerful driver in the background was reflation taking root around the world, as detailed in our Global Macro Outlook of January 2017.

The surge in EM valuations comes at a time when we believe the dollar could resume its upswing and uncertainty over U.S. fiscal and trade policies is high. This is why we have lowered our EM debt view to “neutral” in the short term.

Our long-term view on EM assets, however, is supportive because we see positive fundamentals. Key is improvement in our outlook for developed market growth. Our BlackRock GPS, a proprietary indicator that incorporates big data signals to provide a handle on the economic growth outlook, shows consensus growth forecasts are still too cautious. These improving fundamentals should eventually boost EM growth.

Jeffrey Rosenberg
Chief Fixed Income Strategist
Jeffrey Rosenberg, Managing Director, is BlackRock's Chief Fixed Income Strategist with responsibilities in developing BlackRock's strategic and tactical views on sector ...
Pablo Goldberg
Portfolio Manager, BlackRock’s
Emerging Market Debt Team
Head of Agency MBS, BlackRock’s
Americas Fixed Income Group
Sergio Trigo Paz
Head of BlackRock Emerging Market Fixed Income