The Democrats, taking effective control of the Senate in 2021 marked an important political development in Q1. Joe Biden was sworn in as President and announced a $1.9 trillion fiscal recovery plan bringing relief to the market. Yield spreads on riskier assets rose amidst rising inflation expectations, and corporate and emerging market bonds experienced their first negative month since October.
February brought continuous progress on vaccination programmes and better than expected macro data, which consequently increased expectations for faster growth and higher inflation in the US. A surprisingly weak 7-year treasury auction triggered a large sell-off on 5-year treasuries – adding to the upward yield pressure.
March saw the first decisive change in the Emerging Markets (EM) policy mix since the beginning of the crisis. Central banks in Turkey, Russia and Brazil hiked their policy rates. Bank of Mexico put a halt on its easing cycle, acknowledged a worrying uptick in inflation and expressed financial stability concerns. In China, Amundi expects the central bank to leave headline policy rates and RRR (Reserve Requirement Ratio) unchanged, even though their message is clear: normalising policy with a tightening bias.
Quarterly performance analysis
All EM fixed income asset classes closed with negative returns. EM debt flows were mixed, starting strong at the beginning of the year and falling towards March, driven by both Hard Currency (HC) and Local Currency (LC) debt flows.
Starting with HC, the Fund’s directional positioning (overweight DTS – Duration Times Spread) hurt performance given the weak performance of EM HC. The Fund’s overweight positioning in Argentina and Brazil limited performance but was offset by gains in Colombia and Peru short vs. benchmark. An overweight in Indonesia, Nigeria and Oman aided performance, though an overweight in Romania and Ukraine limited performance.
The Fund was flat to benchmark from its local duration bet. An overweight to Mexico benefitted, however an overweight in Brazil and Peru limited performance. Gains from positioning in Thailand and Romania were offset by losses in an overweight to South Africa. In EM FX (Foreign Exchange), an underweight in MYR (Malaysian Ringgit) and THB (Thai Baht) offset some of the losses from the long on BRL (Brazilian Real).
On HC, the Fund increased exposure to Egypt based on a solid macro performance during the COVID-19 crisis. Exposure to Bahrain and Ghana was increased based on attractive valuations. The Fund took some profit from its Mexican quasi-sovereign exposure, while it cut from exposure to South Africa on the belief its growth outlook remains challenging beyond the 2021 base-effect bounce.
On LC, the Fund decreased its overweight positioning to Philippine and Brazilian local rates and maintained them entering April. Gradually moved from an overweight to underweight Malaysian local rates as the bond curve is viewed to be expensive given inflation outlook for the country. Decreased exposure to Polish and Thai rates.
On EM FX, the Fund changed from an underweight to an overweight in CNY (Chinese Yuan), as a relative value bet vs. the TWD (New Taiwan Dollar). Increased exposure to PLN (Polish Zloty), and to RUB (Russian Ruble) as the country seems to have attractive fundamentals and valuations, balanced by its geopolitical risk. The Fund went underweight to MYR on the belief that Malaysia needs a weaker currency to offset the negative fiscal impact of lower oil prices. An underweight to PHP (Philippine Peso) as valuations seem to be expensive on the currency, and to MXN (Mexican Peso) on the belief that there are uncertainties surrounding fiscal and monetary policies combined with a steeper U.S. yield curve which makes the currency more vulnerable. Finally, an underweight to the TRY following the unexpected replacement of the Turkish central bank governor.
Whilst EM spreads are flat year-to-date, they have significantly underperformed their beta to global risk assets, including to global equities, but especially vs. US high yield (HY). Whilst standalone valuations have not improved, relative valuations have improved significantly for EM credit. The Fund Manager was previously of the view that the scope for decompression had evaporated with the outperformance of EM HY between Q3, 2020 and January 2021, it has since had some mild decompression in recent weeks, which has opened up opportunities in HY space.
Amundi thinks spreads in commodity exporting countries have significantly lagged commodity prices, and that is where the bulk of opportunities may lie in the HY space. And given the sheer magnitude of fiscal and monetary stimulus that has been injected into the global financial system – especially by the U.S. – over the past twelve months, the structural bull cycle in global rates – including in EM local rates – is likely behind us.