Given that Treasury yields are at multi-decade lows as a result of deflation fears and the Federal Reserve’s open market operations designed to keep interest rates where they are, one might expect investors to start piling into higher yielding sovereign debt.
For those that have, it appears as though the trend still favors positioning into U.S. government paper as opposed to sovereign issues.
Take a look below at the price ratio of the iShares JPMorgan USD Emerging Markets Bond Fund (NYSEArca: EMB) relative to the iShares 7-10 Treasury Bond Fund (NYSEArca: IEF).
As a reminder, a rising price ratio means the numerator/EMB is outperforming (up more/down less) the denominator/IEF. A falling ratio means the opposite, whereby the numerator/EMB underperforms the denominator/IEF.
The ratio collapsed in early August as the summer crash of 2011 I had been calling for as early as June occurred. [Summer Stock Crash]
Effectively, yields rose in sovereign debt while Treasury interest rates dropped at the same time in a classic flight to safety trade. The reasoning for the weakness may be because of contagion concerns over a default in Greece affecting more than just Europe, but Brazil, Mexico, Russia, Turkey, and the Philippines, which make up over 37% of the ETF’s country holdings.
The ratio trend does still seem to be still headed lower, however should the fall melt-up of 2011 that I am now calling for occur, it might be worth considering that possibility that sovereign debt looks relatively attractive at these levels, especially since the decline over the past two months has taken the ratio back in time to early 2009 levels. [Fall Melt-Up?]
This of course assumes that things don’t get worse, and that the Europeans can contain any follow-through damage occurring from Greece – something which I think is a good possibility given how well publicized the problems are now.
The author, Pension Partners, LLC, and/or its clients may hold positions in securities mentioned in this article at time of writing. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities.
Post updated to correct currency impact on EMB.