EM sovereign credit initiated a rebound at the turn of the quarter (+3% QTD) as Treasuries bounced back after having registered the worst quarterly returns since the early eighties (-4.3% for the Barclays U.S. Treasuries in Q1). There is indeed a strong relationship between EM sovereign credit and Treasuries. For an asset mostly denominated in USD, the former represents a higher yielding alternative to Treasuries, whose demand fluctuates according to risk preferences and relative yield dynamics. But developments in the Treasury market are not the only determinant of EM performance. Almost the entire commodity complex is also an important driver of EM sovereign credit and this tailwind partially counterbalanced the adverse Treasury effect in recent months.
In line with broader market developments, EM Global Macro strategies rebounded quarter-to-date, up +1.6% as of 07/05, but still down -1.3% year-to-date. The rebound in EM currencies was also supportive and as such, we revisit our stance on EM Macro strategies.
In our view, the market environment should remain adverse, with Treasury yields expected to head towards 2%. Also, spreads are tight at present, at 333bps over Treasuries. Our stance on the strategy was downgraded in March to N and we now downgrade it to Underweight. We remain defensive as U.S. inflation prospects are putting renewed upward pressure on Treasury yields and the USD. Also, the commodity tailwind can be misleading. Despite the stellar rise in oil prices, the EMBI Saudi Arabia, UAE, Russia or Qatar were down year-to-date in a range of -3% and -5%. But there is some room for arbitrage opportunities considering the diversity of local situations at the issuer level. For instance, Mexico has managed to cut rates in recent months and is likely to be bolstered by the U.S. recovery. It also benefits from a better Covid-19 situation than the rest of Latin America. On the contrary, Brazil hiked rates two times this year, by a cumulated 150 bps, and the Covid-19 scares may impact negatively the credit profile of the sovereign. Talented managers can take advantage of such opportunities and several strategies are hedged against rises in Treasury yields. But we suggest selectivity and expect EM Macro to underperform.