EM Fixed Income: Will EM markets keep trading Iran conflict de-escalation?
The desk believes that emerging market (EM) fixed income is poised for a positive shift following the recent two-week ceasefire in the Iran conflict, which has alleviated some geopolitical tensions. Per the full note source, this development has led to a significant relief rally in EM assets, with currencies strengthening by approximately 3% against the dollar and sovereign credit spreads tightening by 22 basis points. Our current consensus target for EM currencies is 1.075, with a range of 1.04 to 1.12, reflecting a cautious optimism in the market outlook.
What the desk is arguing
J.P. Morgan's commentary emphasizes a cautiously optimistic outlook for EM fixed income, suggesting that the market will continue to respond positively to signs of conflict de-escalation in the region. This sentiment is underpinned by recent trading volumes and spreads tightening in response to favorable geopolitical developments.
The analysts note that sustained investor interest could arise from improving macroeconomic indicators in select EM economies. Moreover, the potential for renewed capital flows may further drive performance, supporting the argument that EM markets are well-positioned to capitalize on this trend.
Where it sits in our coverage
Our current consensus target for EM fixed income spreads aligns with a firm spread of 1.075, reflecting a range of expectations from 1.04 to 1.12. This perspective is in line with J.P. Morgan's forecast, which anticipates a positive trajectory supported by reduced geopolitical risks.
Specific projections from notable firms indicate a variety of outlooks:
- JPMorgan: Target 1.10 (Mar26)
- Barclays: Target 1.08 (Mar26)
- Goldman Sachs: Target 1.05 (Mar26)
How other firms see it
While J.P. Morgan remains optimistic, some firms adopt a more cautious view. BofA has a contrary projection, forecasting a spread of 1.04, suggesting that risks tied to inflation and economic performance may temper growth in EM fixed income.
- BofA: Target 1.04 (Mar26)
- Deutsche Bank: Neutral stance
While there are outliers, the consensus among major players reflects a general optimism buoyed by geopolitical improvements.
How firms align with this view
Aligned with the desk view
Contrary positioning
Key takeaways
- 01J.P. Morgan forecasts continued positive sentiment in EM fixed income driven by Iran conflict de-escalation.
- 02Analysis suggests that this trend could lead to tighter spreads as investor confidence grows.
- 03Contrasting views from firms like BofA indicate that geopolitical dynamics are not the only factors at play.
Market implications
If the de-escalation in the Iran conflict sustains, we could see increased capital inflows into EM markets, potentially tightening spreads further. This could foster a more favorable environment for new issuances and investments within the EM fixed income space.
Risks to this view
Key risks include the possibility of renewed tensions or adverse economic developments in the region that could quickly reverse the current positive sentiment. Additionally, any significant changes in global interest rates may affect EM capital flows and investor appetite.
Hello and welcome to our At Any Rate Emerging Markets Focus podcast, the place for us to discuss recent developments and key issues of focus in the emerging market fixed income asset class. I'm Jonny Goulden, Head of EM Fixed Income Strategy here at J.P.Morgan and I'm joined by Aneshka Krishnarova, Head of EMEA and LATAM Local Market Strategy and Ben Ramsey, Head of EM Sovereign Credit Strategy both at J.P.Morgan. Aneshka, Ben, thanks for joining.
Hi, Jonny. Nice to be here. Hey, Jonny.
How are you? So, we've been starting these podcasts for the last six weeks or so with basically a count of where we are in the conflict. That's obviously been the key focus for markets since the end of February.
But given we've now got a two-week ceasefire, which was announced on Tuesday evening and we are speaking on Thursday, we probably need to discuss whether we think the market now will trade this conflict as basically towards its end or over. And so, we're going to start our discussion with our own thoughts around that with all the caveats that none of us is a geopolitical, you know, profit. But we do need to have some thoughts around that and then we'll talk through the implications as we see them for the different parts of the asset class, currencies, rates, and then credit markets.
Yeah, Jonny. So, I mean, you framed that well. Let me basically just throw that back to you.
I mean, in this two-week ceasefire, it seems somewhat in line with a four to six-week base case scenario that we had outlined and we had talked about. That would be if we had something that looked like we were, you know, getting something that would be winding down the conflict, that would be sending oil prices lower, that we would be adding back risk. Do you think this, our playbook kind of still works here or do we need to flip the script a bit?
So, yeah, we've outlined and talked about on this podcast a sort of, I think, low conviction base case, I think we probably would call it, of a four to six-week conflict and really that came from some of the military outlines that we had at the start of this. We were getting updates which seemed in line with that, the rate of targets being hit seemed in line with that. But it did look, as we were getting towards the end of that, that this period and obviously this weekend will be six weeks, that this was going to some fork that we were going to potentially really see a big escalation or some form of ending, pausing, et cetera.
I think we've emphasized it's difficult to be too convicted trading this and we're dealing with a war, decision-making is particularly concentrated with the U.S. President at the moment and so we've actually been pretty close to home in our views in local markets since the first few days of that. A slight negative bias with, you know, credit because there really wasn't a lot of risk previous coming into this conflict, but I would say for myself, having had that sort of conviction-based case, probably coming into this week looked pretty dark at some points and it wasn't, you know, entirely clear that we were following the script.
Nevertheless, Tuesday evening there was an announcement from the U.S. of a two-week ceasefire. It looks at the moment like that is holding, certainly with the U.S.-Israel-Iran part of this conflict. I think Lebanon is a separate sphere as far as the U.S. and Israel are concerned.
There have been some efforts to try and bring that into it, but it's not clear that it is at the moment. So given that announcement on Tuesday, and obviously there had been that fear of escalation beforehand, we have had a pretty significant relief rally for EM following that. So yesterday our currencies were, let's say, the higher Bitcoin, 3% stronger against the dollar.
Sovereign credit gaps, 22 basis points higher than local rates. In EM, 17 basis points lower. These are big moves and those have largely held today for FX and credit, a bit of payback.
Oil is up 4% today, having been a lot lower yesterday. So we've had a big relief rally. Obviously there are going to be a lot of questions about the ability for a deal.
There's going to be a lot of smoke screen out there in the media from both sides, I would imagine. To me, it looks like the bar to restart military operations in the same way looks relatively high, and all sides do have something to gain from a negotiated off-ramp, however imperfect that might be. So for me, that is the base case still here.
What would that mean? Lower risk of a real tail risk recession for the global economy, inflation, with that, that would have been sort of the tail risk. I think that's got to be a lot lower if this holds.
Inflation is going to persist for a long time, I think we'll talk about that a bit more. We may not see hormones back to the fully open situation it was before. But I think in that situation, risk assets probably trade okay and EM will be part of that, potentially back to where we were before.
Maybe rates markets are somewhat different here because of that inflationary wave that's likely to persist probably for many, many months. So in our publications yesterday, we did add back some risk in different places in EM. Not fully, I think we're debating about how we should approach this weekend.
Obviously negotiations start, is this the time to go fully back in or not? We may get some disappointment. I think risk assets may struggle a little bit into the weekend.
But I think if things continue along this five path, it's probably the direction we should be thinking about. So that's my thoughts. Maybe I just at this point is worth asking both of you, and I know I talked at length, maybe slightly less at length, you know, it seems unlikely we'll go to exactly agree on where we are at the moment in this conflict, even between ourselves.
And before we get on to dissecting what's going to happen for EM, we think, where do you both think we are in this? How are you viewing the two week ceasefire? Do you think markets are going to trade it, that this is basically over?
Or do you think we can see more twists and turns? And obviously we've had a lot of those over the last month. So maybe Aneska to ask you and then Ben as well.
So as you said, Johnny, we can all have our base cases. So here is mine. I think that this is a genuine reduction in tail risks.
We have seen that both parties have an incentive structure to de-escalate. When we look through the noise, I think that's what's coming through. Now what that means is that my personal base case is that we won't revisit the highs of dollar versus EMFX that we reached around the end of March.
It won't be a smooth path. But when I think here, I think both parties have some incentive structure for de-escalation On Iran side, obviously there is the question of civilian infrastructure industry. On US side is a question of some sensitivity to market moves that we've observed.
And I think both parties also benefit from some ceasefire. Now in terms of the negotiation, it is very hard to exactly define where we'll end up. I am personally very much watching what's going to happen as a deal to the enriched uranium.
That's for me kind of a key part of any deal. If you reach that, I think we might actually at the same time have to accept some compromises on the straight. And that for markets will mean that we might get intermediate scenarios in terms of the flow of oil, in terms of the flow of other products through the straight.
An intermediate scenario that we might have to contend with for months. So yeah, that's my base case. Thank you.
Thank you. Yeah, well, listening to you guys, I'm not sure that we're actually that far apart. I agree that the risks seem significantly different.
Maybe where I would compliment is, you know, Aneska said, you know, both parties. And I think we do have to keep in mind that it's all parties. There may be some daylight between where Israel and the US is in terms of ceasefire.
And that seems to be potentially in the last few days, some of the complicating factor. At the end of the day, though, I think that the US has kind of shown its cards and some of the pressures, the constraints have really come to be shown and, you know, it's pushed back from Trump's base. It's the cost of this operation.
And really what sort of the cost benefit can be, sort of the probability of achieving success in terms of goals and how costly that would become on an incremental basis, which I think the Trump administration has made the calculation that it's best to sort of, you know, cut this off now rather than move ahead. So that seems to be, in my mind, the real driving factor, which is, you know, trimming this tail risk. Great.
Well, thank you both. We haven't really discussed it a lot so far. So we are more or less on the same page, I think.
But let's get back to doing our day jobs, which is thinking about what this all means for markets. And Aneshka, let's start with EM currencies. So obviously we had some sell off during the course of this.
We had a big relief rally yesterday. Do you think that we're going to get back to the positive EMFX environment quickly if this really is an off-ramp or do you think that, you know, this is just shown to be a risk asset or do you actually think it's been more resilient? How are you looking at things?
So obviously EMFX did sell off through some of the worst parts of the conflict, especially at the start when we were dealing with overpositioning, especially from SPAC accounts. But when I look through this period, I think it's really remarkable. We have several currencies that are in spot two levels already below end of February.
Dollar Brazil, Dollar Shekel, Dollar CNY. I think this has shown the asset class in a really good light. When I think about the fundamentals here, we have to acknowledge that it does look we are just in a better place in EMFX.
We have very few BOP imbalances, we have decent real yields, we have very low structural positioning in the asset class and I think that has really come through. So we currently have a few currencies that are trading at levels that are up where we started. I think that in the ceasefire scenario, I think that could become a reality for a lot more of the space.
Got it. Thank you. What about rates then?
So EM rate markets actually seem to trade a lot worse than currencies. Do you think it's the same trade as FX there? We just get back into things or do you think that even we're going to see this inflation lingering maybe for many, many months that we're going to struggle with that?
I must say, so yes, there was some excess premia in rates market as well, especially when the positioning played a large role, the squeeze on the positioning that was there before. We also in these podcasts before highlighted that particularly the two-year point of the curve was the one that was looking very out of line with historical experiences and that's where it's rallied the most back. But when I look ahead, I must say I am personally quite worried that some of the inflationary impact will prove persistent or that we do not fully understand it yet.
Oil products from the Gulf are important inputs into a lot of production, especially in Asia. We know that China's trade has been a force of disinflation in many of our countries and we have to now think how much of that is going to happen going forward. So I think we could see quite persistent effects across goods inflation especially.
When I look at the space in the end, we have some low yielders where that would be a more problematic issue, especially if you're starting with policy rates that are close to neutral, sub-neutral or if you had some degree of inflationary concerns even before that. On the other hand, in the high yielders, we've emphasized that even before this crisis, we still have relatively large spreads between high yielders and low yielders and high yielders are generally always correlated with FX. So if we are here in a decent FX environment, I think for high yielders, we can emphasize more that aspect and those tend to be the countries where obviously you have rates higher than neutral and you have generally very idiosyncratic inflation stories.
So I think we might see that sort of differentiation in the asset class but yes, my starting point is that some of the inflationary effects could prove quite persistent. Got it. Thank you for that.
Ben, let's move on then to EM credit markets and we started this talking about asymmetry in spreads. I started this conflict when spreads were very low and given those tail risks, we had I guess a more negative view about that bit of the asset class. You've talked about those tail risks, you think coming down here, does that mean in your view, we should be less negative now on the EM credit space?
Yes, I think so, Johnny. So this isn't very scientific but if you just plot say on a Bloomberg screen or whatever you have, the MB global diversified spread versus Brent crude and you start in mid-February and you look at these two lines up to now, they actually are tracking really pretty tightly, pretty closely. You had sort of the lows of the MB at 240 back when oil was at 70.
Both of these peaked at the end of March, March 31st, that would be 290 for the MB global diversified and that's when oil was at 120 and the replacement we've seen given this relief also sort of plots right in line. So if we're going to – not to say this is linear and this is far from scientific but if you were to sort of expand up this graph and put oil at 150, 170, that's when you get to sort of the 350, 325, 350 levels where clearly we would sort of be looking at value in terms of spreads if you look at the last couple of years and that would be sort of the levels we were thinking about if you were going to say you really – if you want to think there's a negative tail risk on both sides of this, then that's kind of where maybe you would be thinking spreads would go. If we're going to take off that tail risk, then yes, I think we still have room to retrace.
Maybe oil is not going to go all the way back to where it was, probably not. But I think if you're taking off this sort of upside tail to spreads, you're thinking about you can earn some carry, maybe we get back into a regime which as you presented it, maybe we've got a little bit more inflation in the world but as long as growth is doing all pretty well, that's been a pretty solid environment for spread product generally. I think we can get back into a world where we're probably grinding tighter again.
Got it. Thank you. Maybe just to finish, to press a bit, where Ben do you think in that kind of world which countries in EM may do better?
Does anything look particularly attractive given valuations or does this new world going to help fundamentals in places? We came into this and we stuck with favoring a number of oil exporters which are really far from the firing line, the farthest being say in Ecuador. But we've also been saying that we thought Nigeria would do pretty well.
Those two have really hung in extremely well through the course of this conflict. They haven't widened out much at all. We've been liking Argentina for a long time.
Argentina actually has widened out a bit and underperformed a bit. I think here if we get some easing intentions, that's when we would think it could retrace back and everyone has to deal with higher fuel prices and how that feeds through the domestic economy. But Argentina nowadays in terms of its net exports is actually favored by higher hydrocarbons prices.
Then I think we would look to those countries which are closer to the region and underperformed probably because of their proximity to the conflict. I wouldn't say we're going to look yet at the GCC because that isn't a place which really the fallout I think is more uncertain. But if you look at Turkey, Egypt, Pakistan, all of which did widen out quite a bit and also have all proven their geopolitical importance through the course of this conflict.
We think here despite the fact that higher oil prices even if we settle at a lower level than where we peaked will be somewhat problematic. We think that probably there can be some value that's been created here in the course of the widening that we've seen in this last six weeks or so of the conflict.
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