This Hasn’t Happened Since Brexit

Ok, so as noted on Tuesday afternoon, emerging markets are certainly not priced for any kind of adverse impact that may (or may not) accompany the Fed’s first baby steps towards normalizing its balance sheet.

EM equities are sitting near six-year highs and thanks to expectations that subdued inflation and D.C. gridlock will continue to leave the Fed largely hamstrung, emerging everything has remained in what Goldman correctly calls “the sweet spot.”

“For EM it has really been the sweet spot with strong global growth (including China), commodities range-bound and also still more attractive valuations and carry compared to most DM assets,” the bank writes, in a note out yesterday.

EMReturns

But as we and plenty of others have variously argued, EM is ignoring a multitude of risks including, but certainly not limited to, broad geopolitical turmoil, idiosyncratic concerns (i.e. country-specific problems), and the possibility that the dollar has found what may ultimately prove to be a near-term bottom.

Well with all of that in mind and with the Fed set to let the balance sheet rundown, consider that, as BofAML notes on Wednesday, “front-end EM FX vol is cheaper than G10 vol for the first time since Brexit”: 

EMFXVol

Note the rather glaring disconnect with Xasset vol.:

EMFXVsXAssetVol

Sustainable? Probably not.

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