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US late cycle dynamics and EM bonds
The Emerging View
08 November 2018
The recent volatility in US stocks may be a warning that the US business cycle expansion is moving into its late stages. How would Emerging Markets (EM) bonds perform if US stocks were to begin to underperform and how should EM investors respond? Based on the empirical data, there is no consistent relationship between EM fixed income performance and US stocks. Instead, there appears to be a strong relationship between US policy stimulus on the one hand and the performance of US stocks relative to EM bonds on the other. Specifically, US stocks tend to outperform EM fixed income during periods of strong US policy stimulus. Outside such periods, EM bonds tend to perform in line with, or better than, US stocks. This should be good news for investors considering an allocation to EM bonds. After all, the Fed is tightening policy both qualitatively and quantitatively and the room for additional fiscal stimulus is shrinking fast.