Fixed income market analysis through a macroeconomic lens.
Global growth revised upward The latest round of global PMIs is encouraging for global growth prospects. The February global composite index rose to 52.1, the highest level observed since mid-2022.1 The outlook was particularly strong in services, but even the manufacturing survey pointed to a gradual move back to expansionary territory. In terms of regional contributions, emerging markets were the main driver of the stronger outlook, with robust prospects in India, China and a number of smaller Asian countries. In the developed world, the strongest outlooks could be found in Spain, Ireland and Canada. Overall, the probability of a global recession has fallen. This should help boost investor appetite for emerging market assets, given their front-runner role in driving global economic growth, and may have implications for the US dollar as a scenario in which the rest of the world outperforming the US on the growth front could be dollar-negative.
Significant downgrade in the US capex outlook As part of our US growth watch process, we like to keep an eye on capex expectations. While the capex outlook has until now weathered adverse macro conditions, the latest update of our capex expectations indicator (CEI) points to significant slowdown risks.2 Based on February data, the CEI suggests that capex growth may be flat by midyear, the worst projection since early 2021. Typically, downward revisions in capex tend to rhyme with poorer earnings outlooks, which suggests that the US economy continues to face major headwinds. For signs of resilience, look toward the consumer and the labor market. On that note, the market will focus this week on the nonfarm payroll number to be released on Friday, especially after January’s blockbuster 517,000 print.3 Expectations are for a more moderate 223,000 gain in February. We just hope that the forecasters do a better job this time around. The January miss was a two-sigma event, a statistical term that means they got it horribly wrong.
When bad news becomes good Most of us have heard of the expression “it’s so bad it’s good.” Well, it seems to apply to EM bond flows. 2022 marked the largest EM debt outflows on record.4 But what does that mean for the prospective returns of the asset class? That’s where the good news comes in, at least based on historical data. We looked at every episode in history during which monthly outflows in EM were unusually large — which we defined as a z-score exceeding 1 in absolute value terms.5 We wanted to see if unusually large outflows work as a contrarian indicator. In emerging markets, we found, they do. We observed seven such episodes since 2004. On average, the 12-month return following the large outflow signal stood at 10.95%, with a median of 9.17% and a range of -11.55% to 41.56%.6 That said, the outflow story is only one piece of the puzzle, albeit an important one in the 2023 emerging market debt picture.
Living life on the hedge The cost of hedging continues to benefit US-based investors, given favorable interest rate differentials. The US investor gets a better deal than free euro-denominated hedging: They actually get paid to hedge their EUR exposure. 204 basis points, to be exact.7 It is not as favorable as the 321-basis-point negative cost of hedging that we observed back in mid-October, but it remains attractive nonetheless. As a result, EUR IG credit yields looks very enticing on a currency-hedged basis. While the unhedged EUR IG corporate yield currently stands at 4.48%, when factoring the favorable hedging cost, the EUR-hedged IG corp yield becomes 6.52%.8 That is a handsome 100 bps more than US IG corp.9 In other words, we think it makes sense for the US-based investor to consider crossing borders and diversifying their geographical exposure. Another group of global fixed income investors are particularly sensitive to hedging costs: Japanese institutional investors, because they need to hunt for yields, wherever they might be. In Japan as well, it may make sense to look abroad. The local yield on Japanese IG corp currently stands at 0.85%, which is well below the hedged EUR IG corp yield of 1.32%.10 Overall, seeking global opportunities beyond their local market can be an attractive strategy for many investors.
Endnotes:
1 Source: Bloomberg, S&P Global. JPMorgan Global Composite PMI. Based on February 2023 data.
2 Source: Bloomberg, US Federal Reserve. The CEI aggregates 5 FED regional surveys on Capex spending. Expectations (Dallas, Richmond, Kansas City, New York, Philadelphia). The CEI is based on the average z-score of the five components. The z-score is a measure of deviation from the average in units of standard deviation.
3 Source: Bloomberg, the Bureau of Labor Statistics. Data as of January 2023. Bloomberg Consensus represents the median forecast of surveys.
4 Source: J.P. Morgan, monthly EM bond flows. Up to February 2023.
5 A z-score is a measure of deviation from the average in units of standard deviation.
6 Source: Bloomberg, J.P. Morgan. Based on the J.P. Morgan EMBI Global Diversified Composite index. The returns are calculated using monthly data.
7 Source: Bloomberg. Cost of EUR hedge from USD based on the 3-month FX forwards. As of 6 March 2023.
8 Source: Bloomberg EUR IG Corporate index. Yield to worst. LECPYW index. Data as of 6 March 2023.
9 Source: Bloomberg US IG Corporate index. Yield to worst. LECPYW index. Data as of 6 March 2023.
10 Source: Bloomberg. Bloomberg Asian-Pacific Japan Corporate index. ISMA yield. Data as of 6 March 2023. Cost of EUR hedge from JPY based on the 3-month FX forwards. As of 6 March 2023.
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