A practitioner's guide to finding alpha in fixed income trading in emerging markets

Emerging fixed income markets are both large and fast growing. China, currently the second largest economy in the world, is predicted to overtake the United States by 2030. Chinese fixed income markets are worth more than $11 trillion USD and are being added to global fixed income indices starting in 2019. Access for foreigners to the Indian fixed income market, valued at almost 1trn USD, is also becoming easier – a trend repeated in emerging markets around the world. The move to include large Emerging Market (EM) fixed income markets into non-EM benchmarks requires non-EM specialists to understand EM fixed income. Trading Fixed Income in Emerging Markets examines the principle drivers for EM fixed income investing. This timely guide suggests a more systematic approach to EM fixed income trading with a focus on practical trading rules on how to generate alpha, assisting EM practitioners to limit market-share losses to passive investment vehicles. 

The definitive text on trading EM fixed income, this book is heavily data-driven – every trading rule is thoroughly back-tested over the last 10+ years. Case studies help readers identify and benefit from market regularities, while discussions of the business cycle and typical EM events inform and optimise trading strategies. Topics include portfolio construction, how to apply ESG principles to EM and the future of EM investing in the realm of Big Data and machine learning. Written by practitioners for practitioners, this book:

• Provides effective, immediately-accessible tools
• Covers all three fixed income asset classes: EMFX, EM local rates and EM credit
• Thoroughly analyses the impact of the global macro cycle on EM investing
• Examines the influence of the financial rise of China and its fixed income markets
• Includes case studies of trades that illustrate how markets typically behave in certain situations 

The first book of its kind, Trading Fixed Income in Emerging Markets: A Practitioner’s Guide is an indispensable resource for EM fund managers, analysts and strategists, sell-side professionals in EM and non-EM specialists considering activity in emerging markets.

DR. DIRK WILLER is a Managing Director and Global Head of Emerging Market FX and Fixed Income Strategy at Citi Research in NY. His research covers global emerging markets for FX, local rates, and credit. His expertise further extends to the analysis of developments in G3 markets and their impact on global emerging markets. Dirk and his team have been ranked as the top team in the 2019 institutional investor survey for emerging markets strategy in FX and rates for Latam, CEEMEA and Asia. In Latam Dirk has been ranked first for four years in a row. Dirk's credit team has also been ranked among the top teams for Latam in the last years. Dirk is frequently quoted in the financial press, including Bloomberg, Reuters, Financial Times and the WSJ, as well as interviewed on TV. Previously, Dirk worked at Omega Advisors and RHG Capital as a global macro strategist and at Swiss Bank as Russia strategist. Before his work on the buy and sell side Dirk advised the Russian government under Deputy Prime Minister Anatoly Chubais during the successful stabilization period in the early 90ies. Dirk started his studies at the University of St. Gallen, Switzerland, and holds a PhD and a MSc with distinction in Economics from the London School of Economics. Dirk is a member of Atlantik-Bruecke and the Economics Club of New York. He resides in NYC with his wife and four daughters.

RAM BALA CHANDRAN is a Portfolio Manager on the Emerging Markets Debt team responsible for FX and rates management, covering Latin America. Prior to joining Neuberger Berman, Ram held a similar role at ING Investment Management. Before that he worked at Citigroup as an Latin American FX and local markets strategist. Ram holds a Bachelor's degree in Mechanical Engineering from the Indian Institute of Technology, Madras, India and earned a Master of Science in Computation for Design and Optimization from the Massachusetts Institute of Technology (MIT), Cambridge.

KENNETH LAM is a Director in Latam Strategy at Citi Research, with a focus on foreign exchange and local market fixed income. Previously Kenneth worked in US rates and mortgage trading as well as FX Structuring at Citi. Kenneth holds a Bachelor's degree in Systems Design Engineering from University of Waterloo and a Master's degree in Computational Finance from Carnegie Mellon University.

Preface xxv

Acknowledgments xxxi

Acknowledgments xxxiii

Acknowledgments xxxv

Acronyms xxxvii

Introduction iii

1 EM FX and Fixed Income: Where the Opportunities Lie 1

1.1 EM Debt - Growing too Fast to Ignore 1

1.2 Returns too Attractive to Ignore  5

1.3 EM as Alpha Opportunity   10

1.4 Scope for even More Alpha      13

1.5 Summary   18

2 Global Macro Rules 19

2.1 What you need to get right: 65% global, 35% local  . 20

2.2 When the US sneezes, the World (still) Catches a Cold  28

2.3 EM Central Banks Stimulate, as Fast as Markets Allow  32

2.4 When Bullish US Rates, EM Rates Outperform EM Credit . 34

2.5 When bullish EUR overweight CEEMEA over Asia   41

2.6 When Bullish Commodities Overweight Latam over Asia  45

2.7 Risk Aversion Barely Hurts EM Rates 52

2.8 Rising US High Yield Spreads Worse than Rising VIX  . 57

2.9 Summary   59

3 China - the only Emerging Market that Counts 61

3.1 Global Business Cycle Made in China 61

3.2 The Commodity Link 64

3.3 On Leverage  . 68

3.4 Current Account Surpluses No More     69

3.5 Enter the Capital Account   70

3.6 Reading the CNY Tea Leaves      75

3.7 CGBs —the JGBs for Millennials  83

3.8 The Grand Decoupling?   87

3.9 Summary   89

4 HowtoTradeEMFX 91

4.1 Only the JPY is special   91

4.2 No Helping Hand from EM Rates     94

4.3 Carry works - if you are Japanese  98

4.4 Current accounts: Measuring Risk the Old Fashioned Way . 106

4.5 Going for Growth . 112

4.6 Modest Value in Valuation      114

4.7 Terms of Trade  118

4.8 Technicals to the Rescue   120

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4.9 Flows Follow, don’t Follow the Flows     125

4.10 Positioning with Positions   132

4.11 Going with the Seasons   136

4.12 Volatility - Foe, not Friend   138

4.13 Summary   140

5 How to Trade EMFX - Event Guide 143

5.1 Chaining the FX Vigilantes      143

5.2 Intervention at Work 145

5.3 Emergency Rate Hikes—only for Emergencies   . 152

5.4 Capital Controls, IMF, or...China  157

5.5 IMF Packages Stabilize FX - Eventually 165

5.6 EM Elections—of Market Foes and White Knights  . 166

Mexico turns Populist  171

5.7 Trading Data  173

5.8 Summary   177

6 How to Trade Emerging Market Rates—The Cycle 179

6.1 Emerging Markets: a Definition for Rates Traders   180

6.2 The Structural EM Trade is Dead; Long Live the Cycle  183

6.3 US Lessons for EM Rates—Turning Points    185

6.4 US lessons for EM rates—after the Turn    191

6.5 The Power of Patience: Receive around last Hike until Last Cut

is Close  . 194

6.6 More on Patience: Pay into First Hike until Last Hike Close . 196

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6.7 Steepeners: Receivers for Chicken     197

6.8 Flatteners: Payers for Chicken      200

6.9 How to Trade QE . 202

6.10 It is Tough to be an EM Central Banker    206

6.11 EMFX as an Unpleasant Constraint on EM Central Bankers . 207

6.12 Commodity Prices as an Unpleasant Constraint on EM Central

Bankers   210

6.13 The Fed as an Unpleasant Constraint on EM Central Bankers 215

6.14 Inflation Forecasting in EM      217

6.15 Peaks in Inflation as Holy Grail  220

6.16 EM Rates—Trading the Cycle in the Front    222

6.17 EM Rates—the Impact of US Treasuries    228

6.18 EM—Curvy  . 232

6.19 Does Valuation Work? 236

6.20 Term Premia—Use Sparingly      239

6.21 Sliding down the Slope 242

6.22 Fiscal—Falling Flat . 243

6.23 Summary   245

7 Real Rates - Simply Superior 247

7.1 Buy Linkers and Sleep Well      247

7.2 How to Sleep even Better   249

7.3 What is Fair ?  254

7.4 Or is it structural ? . 261

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7.5 Summary   263

8 How to Trade EM Rates - Event Guide 265

8.1 Trading Data  265

8.2 Learn to Love Negative Carry      271

8.3 Being Inclusive Pays Off Nicely  273

8.4 Trading Disasters . 276

8.5 Summary   278

9 How to Trade EM Credit 281

9.1 The Structural Trade is Dead, Long Live the Cycle  . 281

9.2 Carried Away by Momentum      287

9.3 Finding your Sweetspot   291

9.4 The Warren Buffet Trade in EM credit 292

9.5 Improving On Buffet 294

9.6 Credit Selection according to Ray Dalio 297

9.7 Pegs Make it Worse 303

9.8 IMF - What is it Good for ?      304

9.9 Embrace Defaults . 307

9.10 Of Credit Curves 313

9.11 Evaluating Value . 316

9.12 Rating Agencies—Late, but Market Moving   . 320

9.13 External versus Local 325

9.14 Summary   327

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10 Portfolio Construction 331

10.1 Smarter With Benchmarks      331

10.2 Frontier Markets at the Frontier  335

10.3 Portfolio Allocation without Markowitz 337

10.4 Derivatives - Weapons of Mass Alpha 340

10.5 ESG and EM - not Fair !   342

10.6 Summary   349

11 The (near) Future - Big Data, Machine Learning, and What

if there are no Emerging Markets Left 351

11.1 Big Data is Coming....but more Slowly in Fixed Income  352

11.2 Machine Learning - Supervision Needed for Supervised Learning 358

11.3 No Disappearing Act for Emerging Markets    361

11.4 Summary   366

A Basic Concepts 367

Bibliography   371