EM Fixed Income: Assessing a big week for trade and macro data
The desk assesses a pivotal moment for emerging market (EM) fixed income as key trade and macroeconomic data loom, potentially influencing risk sentiment in the broader asset class. According to J.P. Morgan, the evolving landscape underlines the significance of upcoming trade reports and inflation prints on portfolio positioning in EM assets. With the potential for volatility driven by macro data following the recent market shifts, traders should closely monitor these indicators that could affect liquidity and pricing in emerging markets.
What the desk is arguing
The desk posits that upcoming trade and macroeconomic data releases could serve as critical catalysts for EM fixed income markets. Per the full note from J.P. Morgan, these releases are expected to reflect shifts in investor sentiment and risk appetite, particularly as inflation concerns persist across major economies.
Supporting evidence for this outlook hinges on recent market developments. The latest data indicate a tightening in liquidity conditions and fluctuating investor positioning, which could translate into increased volatility in EM bond yields. A focus on forthcoming economic indicators is essential as they may wield considerable influence over market dynamics.
The alternative read would be that if market sentiment remains stable and inflation data comes in modestly, then EM fixed income may experience a more benign trajectory without substantial volatility, thus appealing to risk-averse investors.
Investors should watch the upcoming trade balance figures and inflation reports as catalysts for potential market movements in EM fixed income. A key level to monitor would be the 1.05 threshold for segments within the EM spectrum, which could signal a shift in risk sentiment if breached.
Risks to this view
A significant catalyst that could invalidate this outlook would be an unexpected shift in global central bank policies, particularly if major economies signal a faster-than-anticipated tightening cycle. This could lead to decreased appetite for riskier assets and a sell-off in EM fixed income.
Hello, and welcome to our At Any Rate Emerging Market Focus podcast, a place for us to discuss recent developments and key issues of focus in the Emerging Market Fixed Income Asset Class. I'm Jonny Goulden in the EM Fixed Income Strategy team here at J.P. Morgan, and I'm joined by Aneshka Krista-Rova, also in our EM Fixed Income Strategy team at J.P.
Morgan. Hi, Aneshka, thanks for joining. Hi, thanks for having me on.
So it's been a pretty busy week, both in terms of economic data and the other near-term focus for EM markets, which has been U.S. trade policy. We had a raft of trade deals which were announced, although many of the details are still not very clear, with then-U.S. tariffs announced yesterday on a large number of EM countries. And then we have just had a humdinger of a downside U.S. payrolls report with very large downward revisions, which is causing big moves in markets.
So in today's discussion, let's try and have a first take on what we think all of this means for EM markets and how the different parts of the asset class have been reacting as this data is pretty hot off the press. Let's start with the overall risk environment for EM. What did we get for EM countries in the tariff announcements?
And is this better or worse than markets were thinking? OK, so starting with the tariffs, my sense is that the overall tariff environment after these August 1st levels is one which is probably worse than we would have thought before we had started any of this. And I think it's important to recognize that because we've been through so many iterations of this that if we talked about a level of tariffs in the U.S. which is getting close to 20 percent as an average tariff rate, I think we would say, you know, and our economists would say this is a drag on economic activity and inflation in the U.S.
And so it's worth taking a step back and just thinking about that environment. I think there's a couple of mitigating factors, again, which our economists have been highlighting. One is the speed of tariffs.
Obviously, when we were looking back in Liberation Day, it looked like there was this wall coming. And what has been instead has been this gradual slope, even though we're getting to a place which is not too dissimilar. But also there has been the second point, some flexibility or reflexivity in the U.S. trade and tariff levels.
Maybe another way of putting that is the market doesn't take these at face value because they can change quite quickly and they can change depending on some of the responses to them. So I think that sort of overall, when you look at what EM countries have had here, most EM countries are now at a 15 percent tariff level for exports into the U.S. Asia generally higher.
So Thailand, Philippines, Malaysia, Indonesia, all 19 percent. Taiwan, Vietnam, 20 percent, 25 percent. India, that's been probably a downside surprise this week and not just related to trade, it seems.
And then we have a bunch of EM special cases. Obviously, China is still being negotiated. That was kicked again down the road.
Mexico looks like there is some positive negotiation going on around the fentanyl tariffs. And then Brazil has also been a downside surprise this week in that sense, much higher rate of 50 percent. But now we have some product specific exemptions.
On top of that, there is a 40 percent on imports into the U.S. which are deemed as trans shipments. So we'll need to see how that's going to be implemented as well. I would say it's going to take a bit of time for everyone to work through all of this.
And some of those key EM countries are still not settled. It looks like we're going to end on something which has got a U.S. tariff rate up, getting closer towards that 20 percent mark. I think that's uncomfortable in terms of possible outcomes had we started this and getting closer to where it looked like things were on Liberation Day.
Adding these tariff developments to the economic data we have had this week, what should the overall stance be on EM markets here? Yeah. So as well as that, and we talked, I think, in last week's podcast, there's a lot about how this week was going to be a very consequential week.
And actually it has been, I would say. And there's still as we're recording this data still to come on Friday afternoon. Generally, in terms of the data flow this week, we probably started or in the middle of the week seen probably a more hawkish set of data and development, core PCE, the Fed's press conference, which was maybe not indicating a hurry to ease here.
GDP has been coming in generally better in the second quarter, although there is a lot of distortion in that. That's true in both the U.S. and many EM countries. So you will see upward revisions in a lot of the 2025 growth numbers because of that, really because of those Q2 surprises.
But I think our economists are also emphasizing that the forward-looking component is one of slowing growth here. And that looked like sort of a forecast of a second half growth slowdown, which wasn't getting as much help from the data. But today's payrolls print probably puts quite a different spin on that.
And certainly it feels like markets are in a real reassessment here. We had a downside surprise today, and payrolls has generally been surprising on the upside. But then there were really large revisions to the last couple of prints.
So just to give a summary of that, before today, the three-month monthly payroll was plus 150,000 in the U.S., which looks like an economy which is basically humming along quite nicely. And now that three-month average is 35,000 only, and that's much more of a worrying number. So I think when we think about that and digest it in EM, we're going to need some digesting, probably more on the local markets.
We're going to need some thought on. In our overall views, we have been pretty light in top-down, a tricky technical summer period we had felt. So a more neutral set of views across EM currencies, rates and corporates.
We have been more negatively biased in sovereign credit, given how low spreads are. I think we've been okay at the moment for that, but I think we are going to need to think about local markets given that downside in U.S. economic data. So maybe, Aneshka, let's come to you and turn straight to that.
And we'll start with currencies. So I guess what's going on in EM currencies? But I think before today, we had quite a strange situation where risk markets, all-time best level.
So U.S. equities, U.S. high-grade credit spreads, all-time lows. But actually, EMFX has not been trading very well for the last few weeks. So what's going on there?
And what do you think your first sense of what this negative payrolls print is going to mean for EM currencies? Yes, so the EMFX market indeed has been very interesting. The way I would look at it is that at some moments over the past month, the trading environment for EMFX has become just very, very technical.
We got that signal from our favorite indicator, the EMFX risk appetite index that we run, which told us at the start of July that the market has gotten very over-positioned in EMFX, very long, very positioned on a bearish theme. At that moment, I think the market has simply switched to trade technicals more than any fundamentals. We have had a correction.
And actually, what our EMFX risk appetite index tells us, some of that access has come out. But then another very technical issue has come into play, and that is the usually very negative August seasonality. And in FX markets, we never really know why seasonality works.
Occasionally, we might have a reason. I do not think that there is actually any good reason for the August seasonality. Occasionally, we see weaker trade balances, weaker current accounts, larger dividend payments.
But overall, it is a very technical factor. And I think that that is what has been driving markets. But if you just step back, if you just step back and think, why are the technicals suddenly becoming more important than the macro?
And I think the reason has been that the market has appreciated the developments, the themes to a very large degree very quickly. And then we are simply stepping back again from that. Now, I think what we are experiencing with this trend today is that the main theme, if you look at a structural theme, that is a theme of fading US exceptionalism, which obviously allows a lot of currencies to strengthen versus the dollar, that is suddenly roaring back.
And what we really need to assess here is whether the macro driver is coming back with sufficient strength versus the technical drivers that are probably still telling us that investors are positioned in that direction. Great, thank you. So, let's turn then to the rate side of things in local markets.
It's been an interesting period in rates in EM. I would say generally outperformance here. If you look since just after Liberation Day, we have outperformed US yields in our local bond markets by about 25 basis points.
So, we look like we've been somewhat independent here of US rates. Obviously, US rates are tanking today, particularly at the front end, given this payrolls print. But do you think EM bonds can continue rallying on the back of it?
Do you think we can continue staying somewhat independent of US rates? And what's driving all of that? I really like the word independence in this.
I think once the EM market is not experiencing very acute FX pressures, which has been pretty much the environment since April, suddenly all the idiosyncratic rates, stories, valuations have been able to play out. And I think independence is really the very important word. If I just first start with the front end of what central banks have been doing, it has been very interesting to watch that many central banks have been allowed in this period to do what they thought is best for their economy rather than necessarily being driven by risk premia.
So, not only independence, but we have noticed also some desynchronization. So, central banks that need to cut or perceive need to cut have continued to do so. But actually, we also found central banks that have no longer felt the need and have turned hawkish.
And we have even a central bank in this region, Czech Central Bank, where they're signaling end of the cutting cycle. So, this period where you don't have particular focus on dollar rates, particular focus on exchange rates has allowed a lot of independence, a lot of desynchronization. Now, in the long end, looking at bond yields, indeed, we have outperformed.
That's been a good period. Again, the lack of FX pressures have played hugely into it. When we look at what has driven that outperformance, which countries, it's been primarily focused on the higher yielders with risk premia, where that lack of FX pressure has to really come through.
There's also plenty of countries where you have not done that. So, there has been actually quite a bit of dispersion of performers and outperformers. But I think that the general dollar environment has played hugely into that outperformance.
Let me just turn the focus again. You talked last week with Ben about EM credit spreads being low, in line with what has been going on in global credit markets. Has anything changed on that?
And what is the outlook from here? Yeah. So, I think Ben was making the point last week that the EM credit spreads looked very low to us.
They looked expensive. They went lower. And really, that's been following global credit markets.
So, US investment grade credit spreads, for example, hit all-time lows this week. And we are not at all-time lows in EM sovereigns and corporates, but we are getting back to levels, which if you look at sort of XCCC for EM sovereigns, and if you look at corporates, we're sort of back to 17-year lows, sub-300 basis points for EM sovereign index, the MB, and sub-200 basis points for the EM corporate index. So, I think that that has really been driven by global risk markets, US equities all-time highs, US credit spreads all-time lows.
It's sort of dragging us with it. The view we have kept with EM sovereigns, and it has been a painful one, as we talked about last week, has been that there was sort of an asymmetry here at these levels of spreads. And if you get any wobble on the economic data, and our economists are looking for a wobble in terms of pretty significant slowing in the second half of the year with US inflation making things still difficult for the Fed, that's not the best environment ever, and the spreads are just pricing a very good economic environment.
And so, we've kept with a bit more of a negative bias there in sovereigns. I think after today's print in payrolls, if there is ever going to be a time that you're going to see a bit of spread widening on the back of that sort of slowdown in data, I think it's probably going to be now. And that is probably going to come against a market which is pretty well positioned at this point at valuation levels, which if we look at our fair value models for EM, look pretty expensive.
So, I think that can be a little bit disruptive. It's not that we necessarily need to price in a recession right now, but I think given where risk premium is, it makes sense to think that spreads can go a bit wider, maybe closer back to where our fair value models are, which is sort of 50 basis points wider for EM sovereigns. So, that brings us to the end of this JPMorgan Emerging Markets Focused podcast.
Thanks to Aneshka for joining today and thank you all for listening and we hope to have you back again with us for the next one.