If you’re looking for insights into emerging markets, consider digging into their monetary policies.
This is one strategy employed by Robert Abad, product specialist at Western Asset Management in Pasadena, Calif. “We perform two levels of analysis,” he says.
The first is sovereign analysis. “This is a critical part [of analyzing monetary policy], as it entails assessing the economic, institutional, fiscal and external conditions of the country,” says Abad, whose firm manages the Renaissance Multi-Sector Fixed Income Private Pool. “What we’re trying to determine is whether sovereign metrics have improved or deteriorated over time, and their trajectory going forward.”
For instance, he assesses a country regionally, globally and within credit-rating categories, asking, “How does a particular sovereign compare with its peers?”
Secondly, Abad identifies three determinants of a country’s exchange rate. Those are:
- secular or long-term factors, such as trends in productivity, saving and investing, and exports and imports;
- cyclical or medium-term factors, such as differentials in real interest rates and in real growth rates, both of which help assess the outlook for local bonds; and
- technical or shorter-term factors, such as investor sentiment and positioning, global risk considerations and qualitative factors such as political risk.
The overall analysis “gives us a good sense of the value of a country’s exchange rate, which is essential in determining the effectiveness of its monetary policy,” says Abad.
The rate stuff
When it comes to credit ratings, Abad says his firm looks at the underlying criteria, such as debt-to-GDP, interest coverage on debt, reserve levels or deficit numbers.
“You can slice those [criteria] up in different ways,” he says, “depending on which region you’re talking about — whether it’s emerging, whether it’s frontier.”
In the end, you want “a spectrum of the level of strength or degree of vulnerability of each country […]. Once you overlay spreads or yields or prices, you get a sense of where the relative value lies.”