Reassuring comments from central bank officials and decent corporate earnings marked the start of Q3. This helped outweigh growing concerns about the spread of the more infectious Delta COVID-19 variant in some countries, as well as a regulatory crackdown in China.
Inflation continued to be a key topic as investors weighed the impact of the spreading Delta variant against upbeat forecasts globally. U.S. Treasuries moved higher towards the end of the quarter, along with energy prices. Supply-chain challenges for products like semiconductors lifted inflation anxiety across global markets, as shipping and transport costs remained elevated. In the U.S., the U.S. Federal Reserve announced that it would soon begin slowing the pace of its asset purchases, aiming to end its taper program by mid-2022. The meeting also resulted in a more aggressive indication of rate hikes than prevalent market pricing, as the median projection for the first-rate hike was brought forward into 2022 from 2023.
China’s move to turn private tutoring companies into non-profit organizations worried risk sentiment, with questions on measures around other sectors. Regulations on the technology sector, included a ban on children playing computer games for more than three hours per week. Investors also had to contend with fears around the potential default of a large Chinese property developer and potential spillover effects. The ongoing power shortage in China also contributed to uncertainty.
The central bank of Korea raised interest rates. Colombia joined the Latin American central banks of Brazil, Chile, Peru and Mexico in rate hikes. The central banks of the Czech Republic, Hungary, Russia and Ukraine raised their policy rates over the quarter. Turkey’s central bank lowered its policy rate, despite higher inflation and against consensus expectations. The bank noted that a revision of its monetary policy stance was needed as past monetary tightening was now dampening credit, domestic demand and commercial loans. The IMF approved a general SDR (Special Drawing Rights) injection of $650 billion to its member countries.
Quarterly performance analysis
Emerging markets (EM) had a rather weak quarter of returns. Flows into EM bond funds were mixed, while the year-to-date flows into HC (hard currency) asset classes remain positive.
The fund outperformed its benchmark. The U.S. dollar strengthened throughout the period vs. the Canadian dollar, boosting the performance of both the benchmark and portfolio.
The Fund entered July with an underweight duration positioning and a beta (measured by DTS – duration times spread) overweight vs. the benchmark.
During the quarter, the Fund enhanced its duration underweight vs. the benchmark and ended September with a relative short. The Fund’s duration management had a positive effect on performance, particularly in the latter half of the quarter given the rise in core rates on the back of rising inflationary expectations.
The Fund’s directional overweight exposure to HC bonds helped performance in July and August as spreads compressed on the back of falling COVID-19 cases and improving vaccination rollouts in EMs; less hawkish rhetoric from the U.S. Fed and a re-evaluation of Chinese growth on a potential easing by the central bank. This positive performance was partly offset in September amidst concerns over the Chinese real estate sector, global growth slowdown and global supply shortages.
The Fund’s overweight in Latin America was rewarded by normalizing activity given the positive vaccination rollout. The region also benefitted from surging oil prices. An overweight in Argentina led the gains followed by the overweight in Mexico. An overweight in Brazil generated small losses – aggressive monetary policy tightening, high inflation and an uncertain political outlook weighed on bonds.
On the local currency (LC) duration bet, the Fund benefitted from an overweight in Indonesia and a short in Thailand. An overweight in Romania and South Africa limited performance. EM FX (Foreign Exchange) had a mixed effect on performance. The Fund benefitted from RUB (Russian Rubble) and IDR (Indonesian Rupiah) overweight. A TWD (New Taiwan Dollar) underweight and overweight in Brazil limited performance.
The Fund entered October with a duration underweight vs. the benchmark given the team’s bearish outlook on core rates. The Fund holds an overweight beta exposure to HC bonds, with a preference for high yield versus investment grade given the outperformance of EM growth versus developed markets, higher commodity prices and room for further spread compression.
The Fund has slightly reduced risk exposure during the quarter given rising risks. Country-wise and on the HC side, the Fund added through Benin and Ghana. The Fund reduced exposure to Panama, where it increased the underweight positioning in August, and Paraguay, where it closed the overweight positioning. In September, the Fund was active in adding exposure through high-yielding credits on the back of cheaper valuations. The Fund added through Egypt and Ukraine.
The rating upgrade from Moody’s on Angola and the sovereign’s subsequent outperformance, led to close of the Fund’s overweight as spreads appear to be too tight relative to regional peers. On the LC duration front, the team remains positive on Russia, Romania and Mexico. On EM FX the Fund maintains a positive exposure to RUB, IDR and Ukrainian Hryvna due to their attractive carry and better valuations. The Fund closed its short on Chilean Peso, increased its overweight in IDR and RUB and turned to an underweight in ZAR (South African Rand) and MXN (Mexican Peso).
A number of themes are at play, opening up opportunities for selection. Investors grapple with higher U.S. rates, a growth slowdown in China, increases in commodity prices and multi-speed recoveries.
The rise in inflation throughout 2021 has been a function of reopening effects and technical factors. Whilst this was well-telegraphed and anticipated, the duration and breadth of supply side issues, and a rise in energy prices, have added fuel to the heated inflation environment.
The team is on the lookout for the evolution of the reopening impulse and persistency in supply issues. On U.S. duration, Amundi believes that Treasuries are likely to continue to drift higher and believes the Fed will likely announce the start of tapering at its November meeting, with its bond purchasiine program ending by mid-2022.
The team will be carefully watching the path of U.S. employment data over the coming months. In China, social stability has been the Chinese government’s top priority. Although authorities are enforcing market discipline by maintaining a hard-line stance on leveraged corporates and property developers, we believe the government will not allow panic to spread throughout the financial system.
Amundi has an overall constructive view on EM from a medium-to-long-term perspective. In EM local currency debt, many EM central banks have been quite aggressive in hiking interest rates, at the first sign of inflation. This list includes Russia and Brazil. Local rates have also been trending higher on the back of higher inflation, hawkish central banks, as well as repricing of core rates, particularly U.S. Treasuries.
From Amundi’s perspective, a fast repricing of local rates in selective countries represents an opportunity to receive rates and engage in carry trade opportunities at good levels. Amundi engages in relative value trades, by being long curves that sold off on the back of aggressive central bank hiking, or where local inflation showing signs of peaking.