EM Spreads: The Wider They Go

Mid Week Bond Update

EM Spreads: The Wider They Go

Emerging Market (EM) spreads are at record highs; China's bonds have risen solidly; Treasury yields have turned in their first inversion of the current cycle.

Investors in Emerging Market (EM) debt, both hard- and local-currency, have had it tough in 2018, between country-specific problems in Turkey, Brazil and Argentina, the strength of U.S. dollar, and worries about the prospect of a recession brought about by troubles with trade.

Yet these issues have also resulted in EM debt being perhaps the most undervalued asset class within fixed income according to Ken Leech, Chief Investment Officer of Western Asset. His Q4 Outlook points out that the yield of EM debt as an asset class has neared record “wides” vs. developed-market yields when both are adjusted for their respective rates of inflation (as shown below). In addition, EM currencies as a group are 35% lower than just five years ago, thanks to the strong U.S. dollar.


Chart Courtesy of Western Asset Management.  Source: Bloomberg, HSBC, as of 31 Oct 18. * Real, or inflation-adjusted yield, is the indicated yield adusted for the effects of inflation in their own markets. Past performance is no guarantee of future results. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.

All this suggests that EM debt would be among the biggest beneficiaries of a reduction in any of the global risks currently preoccupying investors. That’s not a prediction that the world will shed its worries at any particular time. Rather, it suggests that the asset class appears to be priced in a worst-case scenario, which might or might not actually take place.

On the rise: China’s currency

The 1.8% rise in the yuan since November 30, from about 6.96 to 6.83 against the U.S. dollar, was believed by some observers to be precipitated by the meeting between Presidents Xi Jinping and Donald Trump at the G20 meeting in Buenos Aires over the weekend.  But other observers point to the confidence shown by the People’s Bank of China (PBoC) in neither injecting nor draining capital into the economy since the end of October.  Instead, the PBoC cut banks’ required reserve ratio by one percentage point to 14.50 percent, releasing some $175 million into the economy for possible use in additional bank lending.

Another key signal of growing confidence: the rally in China’s sovereign bonds, with the yield of the 10-year moving down some 70 basis points to 3.4%, one of the better-performing sovereign bonds this year.

On the Slide: Inversion Sighting: the 2 year - 10 year Treasury

Fans of recession signals finally got their much-anticipated inversion, as the spread between 2-year and 5-year Treasuries fell below zero – albeit by just under 1 basis point.

It is tempting to dismiss this single data point as an anomaly. But one possible trigger of recession may have been lessened, as the Fed considers the backlash from its announcement that it might bring its interest rate into a restrictive, rather than a neutral, range.  While market watchers appear to still anticipate three hikes by the Fed in 2019 after its presumed December move, the FOMC’s own forecast, to be released along with the Fed’s December 19 rate decision, could very well tell a slightly different, and more reassuring message.  In addition, the Fed’s own forecast for growth over the next two years, though not forecasting a recession, are notably lower than the 4.2% annualized growth rate recorded as of June 30, 2018.



The Federal Reserve Board ("Fed") is responsible for the formulation of U.S. policies designed to promote economic growth, full employment, stable prices, and a sustainable pattern of international trade and payments.

Spreads refers to bonds other than Treasury securities and include securities such as agency securities, asset-backed securities, corporate bonds, high-yield bonds and mortgage-backed securities.

“Wides“ refers to the width of the spread between the yields of two similar fixed-income securities. For example, the expression “the bonds closed at session wides” means that the spread between the two bonds was the largest (widest) it had reached during the trading session.

Emerging markets (EM) are nations with social or business activity in the process of rapid growth and industrialization. These nations are sometimes also referred to as developing or less developed countries.



Important Information


All investments involve risk, including possible loss of principal.

The value of investments and the income from them can go down as well as up and investors may not get back the amounts originally invested, and can be affected by changes in interest rates, in exchange rates, general market conditions, political, social and economic developments and other variable factors. Investment involves risks including but not limited to, possible delays in payments and loss of income or capital. Neither Legg Mason nor any of its affiliates guarantees any rate of return or the return of capital invested. 

Equity securities are subject to price fluctuation and possible loss of principal. Fixed-income securities involve interest rate, credit, inflation and reinvestment risks; and possible loss of principal. As interest rates rise, the value of fixed income securities falls.

International investments are subject to special risks including currency fluctuations, social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets.

Commodities and currencies contain heightened risk that include market, political, regulatory, and natural conditions and may not be suitable for all investors.

Past performance is no guarantee of future results.  Please note that an investor cannot invest directly in an index. Unmanaged index returns do not reflect any fees, expenses or sales charges.

The opinions and views expressed herein are not intended to be relied upon as a prediction or forecast of actual future events or performance, guarantee of future results, recommendations or advice.  Statements made in this material are not intended as buy or sell recommendations of any securities. Forward-looking statements are subject to uncertainties that could cause actual developments and results to differ materially from the expectations expressed. This information has been prepared from sources believed reliable but the accuracy and completeness of the information cannot be guaranteed. Information and opinions expressed by either Legg Mason or its affiliates are current as at the date indicated, are subject to change without notice, and do not take into account the particular investment objectives, financial situation or needs of individual investors.

The information in this material is confidential and proprietary and may not be used other than by the intended user. Neither Legg Mason or its affiliates or any of their officer or employee of Legg Mason accepts any liability whatsoever for any loss arising from any use of this material or its contents. This material may not be reproduced, distributed or published without prior written permission from Legg Mason. Distribution of this material may be restricted in certain jurisdictions. Any persons coming into possession of this material should seek advice for details of, and observe such restrictions (if any).

This material may have been prepared by an advisor or entity affiliated with an entity mentioned below through common control and ownership by Legg Mason, Inc.  Unless otherwise noted the “$” (dollar sign) represents U.S. Dollars.

This material is approved for distribution in those countries and to those recipients listed below. Note: this material may not be available in all regions listed.

All investors and eligible counterparties in Europe, the UK, Switzerland:

In Europe (excluding UK and Switzerland), this financial promotion is issued by Legg Mason Investments (Ireland) Limited, registered office 6th Floor, Building Three, Number One Ballsbridge, 126 Pembroke Road, Ballsbridge, Dublin 4, D04 EP27. Registered in Ireland, Company No. 271887. Authorised and regulated by the Central Bank of Ireland.

All Qualified Investors in Switzerland:
In Switzerland, this financial promotion is issued by Legg Mason Investments (Switzerland) GmbH, authorised by the Swiss Financial Market Supervisory Authority FINMA.  Investors in Switzerland: The representative in Switzerland is FIRST INDEPENDENT FUND SERVICES LTD., Klausstrasse 33, 8008 Zurich, Switzerland and the paying agent in Switzerland is NPB Neue Privat Bank AG, Limmatquai 1, 8024 Zurich, Switzerland. Copies of the Articles of Association, the Prospectus, the Key Investor Information documents and the annual and semi-annual reports of the Company may be obtained free of charge from the representative in Switzerland.

All investors in the UK:
In the UK this financial promotion is issued by Legg Mason Investments (Europe) Limited, registered office 201 Bishopsgate, London EC2M 3AB. Registered in England and Wales, Company No. 1732037. Authorized and regulated by the Financial Conduct Authority. Client Services +44 (0)207 070 7444

All Investors in Hong Kong and Singapore:

This material is provided by Legg Mason Asset Management Hong Kong Limited in Hong Kong and Legg Mason Asset Management Singapore Pte. Limited (Registration Number (UEN): 200007942R) in Singapore.

This material has not been reviewed by any regulatory authority in Hong Kong or Singapore.

All Investors in the People’s Republic of China ("PRC"):

This material is provided by Legg Mason Asset Management Hong Kong Limited to intended recipients in the PRC.  The content of this document is only for Press or the PRC investors investing in the QDII Product offered by PRC’s commercial bank in accordance with the regulation of China Banking Regulatory Commission.  Investors should read the offering document prior to any subscription.  Please seek advice from PRC’s commercial banks and/or other professional advisors, if necessary. Please note that Legg Mason and its affiliates are the Managers of the offshore funds invested by QDII Products only.  Legg Mason and its affiliates are not authorized by any regulatory authority to conduct business or investment activities in China.

This material has not been reviewed by any regulatory authority in the PRC.

Distributors and existing investors in Korea and Distributors in Taiwan:

This material is provided by Legg Mason Asset Management Hong Kong Limited to eligible recipients in Korea and by Legg Mason Investments (Taiwan) Limited (Registration Number: (98) Jin Guan Tou Gu Xin Zi Di 001; Address: Suite E, 55F, Taipei 101 Tower, 7, Xin Yi Road, Section 5, Taipei 110, Taiwan, R.O.C.; Tel: (886) 2-8722 1666) in Taiwan. Legg Mason Investments (Taiwan) Limited operates and manages its business independently.

This material has not been reviewed by any regulatory authority in Korea or Taiwan.

All Investors in the Americas:

This material is provided by Legg Mason Investor Services LLC, a U.S. registered Broker-Dealer, which includes Legg Mason Americas International. Legg Mason Investor Services, LLC, Member FINRA/SIPC, and all entities mentioned are subsidiaries of Legg Mason, Inc.

All Investors in Australia and New Zealand:

This document is issued by Legg Mason Asset Management Australia Limited (ABN 76 004 835 839, AFSL 204827).  The information in this document is of a general nature only and is not intended to be, and is not, a complete or definitive statement of matters described in it. It has not been prepared to take into account the investment objectives, financial objectives or particular needs of any particular person.

Forecasts are inherently limited and should not be relied upon as indicators of actual or future performance.

U.S. Treasuries are direct debt obligations issued and backed by the "full faith and credit" of the U.S. government. The U.S. government guarantees the principal and interest payments on U.S. Treasuries when the securities are held to maturity. Unlike U.S. Treasury securities, debt securities issued by the federal agencies and instrumentalities and related investments may or may not be backed by the full faith and credit of the U.S. government. Even when the U.S. government guarantees principal and interest payments on securities, this guarantee does not apply to losses resulting from declines in the market value of these securities.

Commodities and currencies contain heightened risk that include market, political, regulatory, and natural conditions and may not be suitable for all investors.