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EM FX has depreciated against the dollar (CEE FX has outperformed in line with a higher EURUSD), as core yields have continued to move higher (bund yields: +32bp, 10y UST yields: +25bp) and commodity prices have softened. Despite the recent weakness of EMEA EM high yielding FX, we remain comfortable holding short ZAR and RUB position.
EM currencies have especially suffered as the rates increased, and curves steepened when US 10yr yields recently hovered close to 2.4%. So it should be no surprise that benign commentary by Yellen has seen these trends reverse alongside the dip in US yields. While the risks of a yield shock have dissipated, they could re-surface at any time. Below, we review our analysis of what typically happens to emerging market assets during periods when US yields rise significantly.
Since mid-June, the US 10y Treasury yield is up by 19bp (though it is 8bp lower in the past two days), the German 10y has moved up by 35bp, and the average G3 yield is up by 18bp. Over this period, EM currencies have fallen, rates have risen, and curves have bear steepened.
The performance of EM assets during yield shock episodes, defined as a rise in the US 10y yield by at least 50bp. Unpredictably, the results show that higher US yields push up EM rates at both the front- and long-end of the curve, and that yield curves tend to steepen.
Swap rates in the CNY, TRY, and ZAR tends to rise the most when US yields are moving markedly higher. In this context, we took profits on our SAGB 2048 (FX unhedged) bond trade recommendation, given that the position was one of the most vulnerable to large upside moves in DM rates. The swap curves (2s5s) in Russia and Malaysia tend to steepen the most when US yields move higher. Interestingly, RUB rates are the only ones in EM that tend to fall on average during periods of higher rates, with declines in the front end of the curve outpacing declines in the longer end.
EMFX and our theme “in carry we trust” remain our guiding principle to navigate markets. We remain short USDCLP, USDTHB, and USDTRY and will look to add risk going forward.
