6th Mar 2020 - 2:49pm

Man GLG eyes emerging markets slump

Submitted By Hugh Leask | 06/03/2020 - 2:49pm -

The impact of the coronavirus outbreak is revealing underlying weaknesses in emerging market debt, according to Man GLG.

Guillermo Ossés, head of emerging market debt strategies at Man GLG, says the firm is staying negative on EM assets until the risk of a pandemic infection from Covid-19 outbreak has subsided.

He predicted a “steep correction” in both the local and external EM indexes driven by EM FX, credit and local rates.

“EM countries have no room to manoeuvre in this environment and positions in EM assets have not been reduced in size. It took just one day worth of outflows, on 28th February, to drive EM rates to behave as risk and to create a disorderly widening in spreads,” Ossés said in a note on Friday.

The sharp downturn stems from most countries – both developed, but particularly in emerging markets – ultimately lacking the ability to deal with a viral infection spread like China, which enforced strict lockdown measures to curb the contagion, he observed.

Lower levels of coal consumption, real estate sales and transport numbers post-Chinese New Year hint at a “worrisome outlook” for EM debt.

“Even ignoring the risk of contagion, we see limited fiscal headroom in many EM countries – such as Indonesia, South Africa, Turkey, Brazil and Colombia – to deal with a Chinese slowdown. The supply chain, which had already been hit pre-virus by trade and geopolitical concerns, has become significantly more strained after the virus outbreak,” he added.

He suggested rate cuts by central banks will have a limited impact on the supply disruption caused by the epidemic, adding rate cuts might only help slow down the drop in demand triggered by the continued selloff.

“Market positioning seems extremely stretched. Oversubscribed repo auctions and substantial repo funding has gone to finance large US Treasury cash positions, where hedge funds arbitrage cash treasuries with futures. We see similar arbitrage activity across EM curves as they have been a low-vol, high-Sharpe ratio source of return,” he explained.

“Finally, quantitatively driven equity portfolios have been running several turns of leverage - albeit with neutral beta to benchmarks - to attempt to extract alpha, and momentum investors got caught close to limit long risk. This accumulation of leverage – in an environment where volatility has substantially increased – could easily trigger the unwind of the levered positions against a dealer community with no ability or appetite to provide liquidity.”

Tags Markets