Markets are just coming off the back of a volatile week caused by a combination of growing fears over a US recession and the impact of a potential rise in interest rates in Japan and a stronger yen—causing a rush of traders to unwind, what is known as, the yen carry trade. The carry trade is where investors, for years, have benefited from Japanese low interest rates to borrow cheaply in yen and then use it to invest in assets, including high-valued US tech stocks.
Nick Eisinger co-head of emerging markets active fixed income, at Vanguard urges trading desks to be prudent as he expects more market volatility and shocks this year. He discusses what he thinks about stock valuations; the impact of the global sell-off on emerging market (EM) liquidity and analyses whether the market fallout showed signs of more critical, underlying systematic issues.
Finally, the Eisinger sheds light on what to expect this upcoming week and what to pay attention to across the EM debt restructuring and distressed debt space.
Interview Transcript
Jo Gallagher Welcome to Trader TV This Week your insight into how trading desks can prepare you for the week ahead, I’m Jo Gallagher. Today I’m joined by Nick Eisinger at Vanguard to discuss the main topics and events leading this week. Nick, welcome back to the show.
Nick Eisinger Thanks for having me.
Jo Gallagher Set the scene for us, what should trading desks be focusing on this week?
Nick Eisinger This week, markets are going to have another chance to take the pulse or tone of what’s going on in the US economy. That’s front and centre of most people’s minds. Probably most importantly, you’ve got US CPI, that is relevant given the perennial debate around inflation and when the first Fed cut will be and then you’re going to have another range of US activity indicators like IP, and Michigan sentiment.
So it’s going to be an important vantage point for the market to sort of try to take a view as to whether the US is slowing down, as has been the fear most recently, or, in fact, whether the notion of a soft landing is still intact.
Jo Gallagher Markets have seen a lot of volatility over the last week due to the carry trade, and also fears of a US recession. How have emerging markets been impacted by this, and how has Vanguard handled this bout of volatility?
Nick Eisinger So emerging markets have taken quite a big hit off the back of both the volatility or the unwind of the carry trade, if you wish to call it that, as well as the market fears of a US recession. However, it’s not unique to emerging markets. We’ve also seen similar dislocations in parts of the US IG market and US high yield and other markets more globally. Emerging markets typically will trade with a very large beta to this kind of news. So it’s not that surprising to see this. However, we have in recent trading sessions, since that first portion of volatility seen a little bit of a stabilization and a recovery, particularly in better quality parts of emerging markets.
We’ve entered this period of greater volatility with some caution, and that’s largely attributed to the fact that we didn’t like the valuations very much. Valuations are now a little bit cheaper, yet we still see a lot of value in holding additional dry powder. So we’re not quite ready to deploy that risk that we took down. Although we have been adding little chips here and there, and we may well continue to do that this week.
Jo Gallagher How widespread was the shock to the market and what did liquidity look like across EM assets?
Nick Eisinger Well, for a period of time it was pretty widespread and the market was very nervous. Liquidity in certain instruments, particularly in my space in emerging markets, was very, very difficult to source. However, that didn’t last very long, and we did have some recovery and stabilization a couple of days later. And most importantly, what we saw, despite the volatility and the very big and obvious headlines, is we didn’t see any systematic implications. You know, for example, a big closedown of global funding markets. And that I think, suggests to us that things are still quite healthy.
Yes, of course, this is a market correction that may have been worrying, but perhaps it was somewhat healthy and it certainly didn’t bring into consideration any of the more systematic factors, which would make it much, much more worrying and much, much more global.
Jo Gallagher Do you anticipate more shocks later this year?
Nick Eisinger At these sort of valuations, and given that there still are many uncertainties in global financial markets and global economies, I think it’s prudent to expect that there will be some shocks ahead of us. How major is a different matter.
If you look at the history, for example, of carriage rate unwinds VAR shocks if you like, they do tend to have a big initial phase to them, and they have many phases thereafter. And it’s very hard really to make a proper assessment of the extent to which there’s still a lot of this carry trade outstanding. What needs to be unwound? But we do expect that there will be some slowdown in the U.S. economy.
Now, clearly, if that slowdown is modest, as so far we anticipate, and it’s coupled with, I guess, what you could call maintenance cuts by the Fed that actually could be quite good for risk markets and market sentiment in general. And I think that would, broadly speaking, be our base case. But it’s really hard to sort of bet too much on that when valuations are still roughly around fair value to slightly overvalued, I would say.
So our view is that you should preserve some dry powder and keep your risk manageable for the eventuality that we do see more of these unwind shocks ahead.
Jo Gallagher So the last time you were on, we discussed debt restructuring and distressed debt. What’s important to pay attention to in that space for the rest of the year?
Nick Eisinger So this week, the market will likely digest the repercussions of the Ukrainian debt restructuring. That’s something that’s been back and forth for a long time and it’s also an event that’s coming off the coattails of the finalization of a debt deal in Zambia and an expected imminent finalization of a debt deal in Ghana. So we finally have some of these distressed emerging market governments that are coming out of debt restructuring, and the market is being given evidence that these things do eventually happen.
So I think that’s quite a positive development. I would say, however, the bonds either that are about to go into exchanges or the bonds that have already come out of exchanges are looking, you know, relatively rich already. They’re already pricing in quite a lot of the news ahead, which by definition should be better news than what preceded the defaults.
The other important point, I think, is how the liquidity environment plays out for some of these new instruments and many of these new instruments will be non-vanilla bonds. So they will have certain macroeconomic triggers to them. They’ll have step-up coupons and usually those are less straightforward for the market to value. So that I think will be a longer-lasting consideration for emerging market investors.
Jo Gallagher Thank you Nick for your insight and of course you for watching this has been Trader TV This Week.
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