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Trading Fixed Income and FX in Emerging Markets: A Practitioner's Guide
A practitioner's guide to finding alpha in fixed income trading in emerging markets
Emerging fixed income markets are both large and fast growing. China, currently the second largest economy in the world, is predicted to overtake the United States by 2030. Chinese fixed income markets are worth more than $11 trillion USD and are being added to global fixed income indices starting in 2019. Access for foreigners to the Indian fixed income market, valued at almost 1trn USD, is also becoming easier - a trend repeated in emerging markets around the world. The move to include large Emerging Market (EM) fixed income markets into non-EM benchmarks requires non-EM specialists to understand EM fixed income. Trading Fixed Income in Emerging Markets examines the principle drivers for EM fixed income investing. This timely guide suggests a more systematic approach to EM fixed income trading with a focus on practical trading rules on how to generate alpha, assisting EM practitioners to limit market-share losses to passive investment vehicles.
The definitive text on trading EM fixed income, this book is heavily data-driven - every trading rule is thoroughly back-tested over the last 10+ years. Case studies help readers identify and benefit from market regularities, while discussions of the business cycle and typical EM events inform and optimise trading strategies. Topics include portfolio construction, how to apply ESG principles to EM and the future of EM investing in the realm of Big Data and machine learning. Written by practitioners for practitioners, this
Provides effective, immediately-accessible tools Covers all three fixed income asset EMFX, EM local rates and EM credit Thoroughly analyses the impact of the global macro cycle on EM investing Examines the influence of the financial rise of China and its fixed income markets Includes case studies of trades that illustrate how markets typically behave in certain situations The first book of its kind, Trading Fixed Income in Emerging A Practitioner's Guide is an indispensable resource for EM fund managers, analysts and strategists, sell-side professionals in EM and non-EM specialists considering activity in emerging markets.
Emerging fixed income markets are both large and fast growing. China, currently the second largest economy in the world, is predicted to overtake the United States by 2030. Chinese fixed income markets are worth more than $11 trillion USD and are being added to global fixed income indices starting in 2019. Access for foreigners to the Indian fixed income market, valued at almost 1trn USD, is also becoming easier - a trend repeated in emerging markets around the world. The move to include large Emerging Market (EM) fixed income markets into non-EM benchmarks requires non-EM specialists to understand EM fixed income. Trading Fixed Income in Emerging Markets examines the principle drivers for EM fixed income investing. This timely guide suggests a more systematic approach to EM fixed income trading with a focus on practical trading rules on how to generate alpha, assisting EM practitioners to limit market-share losses to passive investment vehicles.
The definitive text on trading EM fixed income, this book is heavily data-driven - every trading rule is thoroughly back-tested over the last 10+ years. Case studies help readers identify and benefit from market regularities, while discussions of the business cycle and typical EM events inform and optimise trading strategies. Topics include portfolio construction, how to apply ESG principles to EM and the future of EM investing in the realm of Big Data and machine learning. Written by practitioners for practitioners, this
Provides effective, immediately-accessible tools Covers all three fixed income asset EMFX, EM local rates and EM credit Thoroughly analyses the impact of the global macro cycle on EM investing Examines the influence of the financial rise of China and its fixed income markets Includes case studies of trades that illustrate how markets typically behave in certain situations The first book of its kind, Trading Fixed Income in Emerging A Practitioner's Guide is an indispensable resource for EM fund managers, analysts and strategists, sell-side professionals in EM and non-EM specialists considering activity in emerging markets.
253 pages, Kindle Edition
Published September 2, 2020
23 people are currently reading
75 people want to read
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Displaying 1 - 4 of 4 reviews
September 5, 2021
EM currency and fixed income markets are large, volatile and growing. Yet they are not as liquid and well covered as DM markets, and this provides opportunities for alpha. The head Citi EM macro strategy collects his years of knowledge and expertise into a fantastic book of investing rules for emerging market currencies and interest rates.
This is one of the most practical books on markets I have read. The rules are simple and evidence-based. The short anecdotal sections on market behaviour during key periods in EM markets (AMLO election, Brazil impeachment, etc) were also very informative and helped me relate the rules to specific instances. The bulk of the book describes rules for EM FX, rates and credit and relationships to the important global macro variables. There are quite a few rules and relationships. I will list the ones that stood out to me the most.
The most important takeaway is the importance of global macro factors to EM. Global factors explain 2/3rds of EMFX and credit moves. Even during the most idiosyncratic event of EM markets, the Rousseff impeachment, the Brazilian real traded in line with the EMFX index. For rates, global forces explain around 1/3rd of the movement. The most important global variables driving EM moves are the USD (EUR-USD more specifically), UST yields, US HY spreads.
#### Rates & Credit
- EM rates at the index level act like DM government bonds except during periods of high risk aversion. Then spreads to DM bonds increase. That doesn't occur often so you should add EM duration when bullish on US rates.
- When you expect severe risk aversion (rapidly rising VIX, liquidity shock, crisis), then you should cut EM rates exposure. It decouples from DM bonds during these shocks.
- Risk aversion (VIX) impacts credit the most, followed by fx and then rates.
- For high level of credit risk rates will move with CDS.
- Most EM central banks put a larger weight on inflation, because they don't have a dual mandate. EMs are more sensitive to commodity prices and these are passed through to a larger extent. For commodity exporters, commodity price increases can lead to lower inflation due to a strengthening currency.
- EM central bank hiking cycles end with peaks in inflation, when inflation is still high but is rolling over. Cuts start happening with inflation 35bps below the high, but still above inflation targets. Cutting cycles extend past the bottoming of inflation. There is a political asymmetry to inflation and monetary policies.
- You want to own receivers at the last hike into the last cut. You want to own payers into the first hike. Steepeners historically do well as receivers to well, and flatteners with payers.
- High real yield outperforms low real yield. Term premia is not very helpful for long term returns. Only useful when it is high relative to recent few months and below zero. Roll down yield and curve steepness is another source of return but often moves contrary to the level. Sometimes its best to own when inverted.
- Latin American countries have deep linker markets (Brazil, Chile and Mexico) . They are larger in Brazil and Chile for historical reasons.
- Quality does better on a vol adjusted basis, within IG and HY, but HY does better than IG.
- Sovereign spreads after default are higher for two years but this with reduced risk of default. Opportunity for alpha.
- Credit can be valued by looking at spread vs rating. If the spread is too high vs the rating, that has historically created alpha.
- Bonds move leading up to rating changes, but the actual rating change usually mark the end of moves in credit. There is no follow through after rating changes.
#### EMFX
- Real rate differentials are an important driver of EMFX. Sell-offs in real rates can cause large negative moves in EM, as US capital gets more expensive/rewarding.
- Increasing oil prices are not bad for oil importers, as it usually coincides with growth. But it does change the relative performance within EMFX.
- If you are bullish on Euro, overweight Polish, czech and hungarian currencies.
- EM countries are on average large food exporters, small materials importers, and large energy importers. There is a large variation within that, so whenever commodities of the main exports do well, terms of trade improve, and the currency does well. In the case of oil: Russia, Malaysia, and Colombia; copper for chile and peru, ags for argentina and brazil, and iron ore for brazil.
- But they give a good counter-example of turkey, which gains more than a dollar in the capital account for every dollar lost in the current due to high oil prices. gulf oil exporters investing into turkey offsets the decline in the current account.
- CNY was historically resilient to risk aversion, but it was a managed currency. over time the currency will be less managed so it might react more to risk.
- Chinese over-leveraging was a story as early as 2004.
- Foreign ownership of chinese assets is low at ~3%, except for the CBG market where it is around 8%. (as of 2018). Foreign inflows are seen as a solution to outflow pressures.
- The PBOC uses seven day reverse repo rate open market transactions. This is a rate the market focuses on.
- DM commodity currencies act similar to EM commodity currencies. The main difference between DM and EM are institutional strength, market depth and market reactions to monetary policy. Higher rates is currency positive in DM, whereas it is currency negative in EM (likely due to inflation risks).
- EM currencies are also strongly effected by international flows. Their capital markets are not as deep.
- carry works, but has been impaired by the dollar bull market. Volatility is negative for EMFX but in particular carry. Currency option implied volatility is a better risk signal than realized vol.
- Current account deficits become very important during times of stress. Otherwise they carry little meaning. Changes in current account deficits do impact currency returns.
- REER doesn't work well as a systematic indicator of value. PPP works much better.
- Breadth is a good indicator of EM strength.
- Flows are not forward looking but they might help you understand positioning. Most of the time you want to position with the crowd, except when something happens that changes the narrative and the crowd is trapped.
- Government reaction to currency weakness has a pattern. First comes fx intervention until reserves get too low, then come emergency rate hikes, then capital controls are possible. If that doesn't end it the next step is policy reform with the potential support of the IMF.
- Cheap currencies bottom on emergency rate hikes. Emergency hikes usually cluster together. IMF packages stabilize currencies over the long term.
- Currencies usually bottom before elections. It's never (initially) as bad as feared, even with market-unfriendly candidates.
This is one of the most practical books on markets I have read. The rules are simple and evidence-based. The short anecdotal sections on market behaviour during key periods in EM markets (AMLO election, Brazil impeachment, etc) were also very informative and helped me relate the rules to specific instances. The bulk of the book describes rules for EM FX, rates and credit and relationships to the important global macro variables. There are quite a few rules and relationships. I will list the ones that stood out to me the most.
The most important takeaway is the importance of global macro factors to EM. Global factors explain 2/3rds of EMFX and credit moves. Even during the most idiosyncratic event of EM markets, the Rousseff impeachment, the Brazilian real traded in line with the EMFX index. For rates, global forces explain around 1/3rd of the movement. The most important global variables driving EM moves are the USD (EUR-USD more specifically), UST yields, US HY spreads.
#### Rates & Credit
- EM rates at the index level act like DM government bonds except during periods of high risk aversion. Then spreads to DM bonds increase. That doesn't occur often so you should add EM duration when bullish on US rates.
- When you expect severe risk aversion (rapidly rising VIX, liquidity shock, crisis), then you should cut EM rates exposure. It decouples from DM bonds during these shocks.
- Risk aversion (VIX) impacts credit the most, followed by fx and then rates.
- For high level of credit risk rates will move with CDS.
- Most EM central banks put a larger weight on inflation, because they don't have a dual mandate. EMs are more sensitive to commodity prices and these are passed through to a larger extent. For commodity exporters, commodity price increases can lead to lower inflation due to a strengthening currency.
- EM central bank hiking cycles end with peaks in inflation, when inflation is still high but is rolling over. Cuts start happening with inflation 35bps below the high, but still above inflation targets. Cutting cycles extend past the bottoming of inflation. There is a political asymmetry to inflation and monetary policies.
- You want to own receivers at the last hike into the last cut. You want to own payers into the first hike. Steepeners historically do well as receivers to well, and flatteners with payers.
- High real yield outperforms low real yield. Term premia is not very helpful for long term returns. Only useful when it is high relative to recent few months and below zero. Roll down yield and curve steepness is another source of return but often moves contrary to the level. Sometimes its best to own when inverted.
- Latin American countries have deep linker markets (Brazil, Chile and Mexico) . They are larger in Brazil and Chile for historical reasons.
- Quality does better on a vol adjusted basis, within IG and HY, but HY does better than IG.
- Sovereign spreads after default are higher for two years but this with reduced risk of default. Opportunity for alpha.
- Credit can be valued by looking at spread vs rating. If the spread is too high vs the rating, that has historically created alpha.
- Bonds move leading up to rating changes, but the actual rating change usually mark the end of moves in credit. There is no follow through after rating changes.
#### EMFX
- Real rate differentials are an important driver of EMFX. Sell-offs in real rates can cause large negative moves in EM, as US capital gets more expensive/rewarding.
- Increasing oil prices are not bad for oil importers, as it usually coincides with growth. But it does change the relative performance within EMFX.
- If you are bullish on Euro, overweight Polish, czech and hungarian currencies.
- EM countries are on average large food exporters, small materials importers, and large energy importers. There is a large variation within that, so whenever commodities of the main exports do well, terms of trade improve, and the currency does well. In the case of oil: Russia, Malaysia, and Colombia; copper for chile and peru, ags for argentina and brazil, and iron ore for brazil.
- But they give a good counter-example of turkey, which gains more than a dollar in the capital account for every dollar lost in the current due to high oil prices. gulf oil exporters investing into turkey offsets the decline in the current account.
- CNY was historically resilient to risk aversion, but it was a managed currency. over time the currency will be less managed so it might react more to risk.
- Chinese over-leveraging was a story as early as 2004.
- Foreign ownership of chinese assets is low at ~3%, except for the CBG market where it is around 8%. (as of 2018). Foreign inflows are seen as a solution to outflow pressures.
- The PBOC uses seven day reverse repo rate open market transactions. This is a rate the market focuses on.
- DM commodity currencies act similar to EM commodity currencies. The main difference between DM and EM are institutional strength, market depth and market reactions to monetary policy. Higher rates is currency positive in DM, whereas it is currency negative in EM (likely due to inflation risks).
- EM currencies are also strongly effected by international flows. Their capital markets are not as deep.
- carry works, but has been impaired by the dollar bull market. Volatility is negative for EMFX but in particular carry. Currency option implied volatility is a better risk signal than realized vol.
- Current account deficits become very important during times of stress. Otherwise they carry little meaning. Changes in current account deficits do impact currency returns.
- REER doesn't work well as a systematic indicator of value. PPP works much better.
- Breadth is a good indicator of EM strength.
- Flows are not forward looking but they might help you understand positioning. Most of the time you want to position with the crowd, except when something happens that changes the narrative and the crowd is trapped.
- Government reaction to currency weakness has a pattern. First comes fx intervention until reserves get too low, then come emergency rate hikes, then capital controls are possible. If that doesn't end it the next step is policy reform with the potential support of the IMF.
- Cheap currencies bottom on emergency rate hikes. Emergency hikes usually cluster together. IMF packages stabilize currencies over the long term.
- Currencies usually bottom before elections. It's never (initially) as bad as feared, even with market-unfriendly candidates.
December 25, 2020
A great guide for investing in emerging markets
It’s a comprehensive guide on how to invest in emerging markets fixed income, all backed up with back tests and charts. As a professional in the field I made great use of it.
It’s a comprehensive guide on how to invest in emerging markets fixed income, all backed up with back tests and charts. As a professional in the field I made great use of it.
July 6, 2023
A very hands on guide on how to approach EMFX and fixed income, I think more useful for experienced professionals than to amateurs.
July 17, 2023
Enjoyable. Potentially too simplistic
Displaying 1 - 4 of 4 reviews