Tension at the long end of the German yield curve - which started in the latter part of April and continued into the first half of May - was a key driver of movements in the bond market. It also affected the US, Australian and Canadian bond markets, according to Sergio Strigo, Head of Emerging Market Debt at Amundi Asset management.
In spite of the supposedly liquid German bond market, 10-year yields climbed dramatically from a low of 5 basis points to a high of 80 basis points, before finishing May at 50 basis points as the tension ran out of steam.
The catalyst for the rise in yields appears to have been driven by a shift in inflation expectations, due to higher oil prices and slightly improved Euro macro data. The movement turned more technical as highly leveraged hedge funds, which had been riding the Quantitative Easing theme through the first quarter started selling down their positions in the face of losses resulting from the change in momentum.
Overall, the bond and credit markets both underperformed. On the foreign exchange side, the USD gained in the second half of the month, earning back more than what was lost at the start of the month, especially against Yen. The GBP was supported by clear election results. Commodity currencies weakened on declining oil prices and easing by the Peoples Bank of China through the month.
The most encouraging sign for emerging market debt was the absence of stress-selling amidst a ~3 standard deviation event in core rates. Both external and local debt held up relatively well. In the case of external debt, spreads tightened relative to both US and German rates, whilst the sell-off in local debt was broadly in line, even though a sharper sell-off was expected, given market conditions and the usual beta in EM assets.
The weakness in EM FX was most likely not driven by the rates sell-off, and the modest 0.5% drag of price return on local debt in the month of May, as well as the relatively modest negative return of 0.8% from hard currency. This is reflective of increased resilience in EM assets in the view of Amundi and adds weight to the argument that EM may be able to withstand the Fed normalization cycle and wider core rates.
EM credit (sovereign and corporate) remains Amundi's preferred asset class but the asset manager is constructive on local rates as well. As a result, the fund lost slightly in April from our overexposure to EM credit and local rates.
Performance on EM credit was somewhat balanced in May. The biggest underperformer was Venezuela (which detracted the fund's relative performance) on the ground of disappointment over the complete absence of meaningful economic reforms.
Amundi reduced its overweight in Eastern Europe by selling part of its Croatia, Romania and Slovenia holdings and reentered Ecuador (reducing then our underweight on LatAm) on relative valuation considerations. It has been less active on local rates where its overweight keeps on being EMEA notably Serbia, Turkey and Hungary where it sees room for the central bank to cut rates by another 30bps, if not more, which would contribute even more to make Hungary one of the steepest curves in EM.
On the FX side, Amundi's focus remains relative value in an attempt to protect against broader USD moves.
On a regional basis, the asset manager is underweight CEEMEA, with shorts in disinflationary currencies such as CZK, HUF and above all ILS, and overweight Latin America, through countries with solid fundamentals such as MXN and CLP. The firm is neutral in Asia after closing its longs in INR and IDR after disappointment with the pace of reforms in both countries and concerns about positioning. Elsewhere in the region, Amundi's overweight in PHP is funded of shorts in disinflationary SGD and THB.