Emerging market fixed income assets suffered worst drawdown in three years, AXA’s Damien Buchet comments

Sovereign and corporate credit spreads, local interest rates, and emerging markets currencies have suffered disproportionately compared to their fundamentals, Damien Buchet, head of Emerging Market Fixed Income at AXA Investment Managers, says

The past month was a special month for emerging market fixed income assets, which suffered their worst drawdown in 3 years. The market re-pricing linked to the reassessment of US monetary policy prospects, was magnified by investor positioning issues in the past month, with tightly valued, long duration assets being hit harder.

Sovereign and corporate credit spreads, local interest rates, and emerging markets currencies have suffered disproportionately compared to their fundamentals, and compared to similar asset classes. Although it is comparable in size to the 2011 crisis, it seems to us that the current situation rather reflects a positioning logic than fundamentals.

Although growth momentum has slowed since February, the fundamental backdrop has not deteriorated markedly in the past two months. Headlines from Turkey or, more recently Brazil, and the realisation that China is not here to save the world, can in some ways explain the wariness towards emerging markets, but do not adequately summarise the overall story.

In our opinion, emerging economies are still much more resilient and able to cope with potential outflows than 5 to 10 years ago. A return to past crises is unlikely, except in some specific situations which do not represent a systemic risk for the asset class.

However, investing in emerging markets is probably not as easy as it was. Differentiation in country risk, the rise of some country specific issues, the breakdown of correlations that we observe among commodities and among emerging markets currencies, all point towards more difficulty in predicting the overall direction of a very diverse market in coming months.

Even if the recent confirmation by the Federal Reserve of early tapering of its QE3 programme disappointed fixed income markets and may trigger some more positioning adjustments, it has the merit of bringing clarity and visibility over the Fed’s moves in the coming months. As a very efficient market, US treasuries should have priced in this new situation.

We think that the recent drawdown has opened fresh value opportunities in the emerging markets space and that the next few weeks provide an attractive entry point for the year. The coming period will however be less predictable than in the past, in terms of overall market direction, as marked by a growing differentiation between countries and sectors.

An approach targeting the yield offered by short duration sovereign and corporate credit appears the most optimal risk/return proposal for investing in emerging market fixed income over the coming period.

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