From currency crises in Argentina and Turkey to extreme volatility in Italian government bonds, it has been an eventful few weeks and months in markets. Yet so far, we have not seen tangible signs of contagion leading to a wider risk aversion cycle. This was a key discussion point during our latest investment policy meetings in which the team analyzed the environment to identify where opportunities may arise.
It has been a summer to forget for some—but not all. While some countries and markets came under extreme selling pressure, others emerged relatively unscathed. The moves have been very specific and more reminiscent of dominoes falling than a systematic crisis, when everything is under stress. This has been most evident in emerging markets, where some countries—such as Romania—have been quite stable, while others have deteriorated rapidly, beginning with Argentina then moving to Turkey, Brazil, Indonesia, and, more recently, Russia and South Africa. Those coming under scrutiny have often been countries with either political uncertainty or a current account deficit that markets are worried could become more difficult to finance with U.S. interest rates rising.
Another country whose fundamentals appeal to the investment team is Colombia. “Inflation is stable at a time when the economy is recovering. While the central bank is expected to raise interest rates next year, we believe that the market is pricing in too many hikes, which helps us to build a picture that the local government bond market is moderately attractive,” said Mr. Fitzsimmons.
Turning attention to developed markets, the investment team noted that for the most part there has been much less volatility. However, not all countries have been immune. The Swedish krona, for example, has significantly underperformed other developed market currencies this year as markets became concerned about the state of the housing market and its potential vulnerability to slowing global growth. Repeated delays in interest rate rises by the Swedish central bank probably hasn’t helped in this regard. However, with elections now out of the way, a key risk has been removed from the market, which may provide a good opportunity to go back into a currency whose volatility may have been excessive given its fundamentals.
J.P. Morgan Currency Volatility Indicies: Emerging Markets vs. G7
As of September 14, 2018
Source: J.P. Morgan. Analysis by T. Rowe Price.
On the bond front, one of the most extreme examples of volatility in developed markets this year has been Italy, where political concerns triggered significant outflows from international investors. “The correction witnessed in the short end of the Italian curve in May corresponded to a 20-standard deviation event,” said Mr. Fitzsimmons. The investment team noted that while long-term concerns remain, there could be a short-term tactical opportunity to benefit from Italy’s attractive valuations, particularly in short-maturity government bonds.
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