VanEck Vectors J.P. Morgan EM Local Currency Bond ETF
The June Fed meeting essentially let markets know that the US central bank officially was changing to an “easing bias.” This was the “technical decision-maker” for which way the market for the dollar (DXY) would break out of its ascending triangle pattern. Typically, this is a bullish continuation pattern, but in this instance we had a false breakout to the upside on 2 prior occasions, and then ultimately broke out of the bottom.
The EMLC call is one intended to express the bearish view that technically the dollar is breaking down. This is also fundamentally confirmed by the Fed pivot to the “easing bias.”
The “easing bias” is apparent from the dive to 0% in the probability that the Fed Funds Rate will remain at 2.25-2.5% at the July 31 meeting.
To gain perspective on what to expect from EMLC under a bearish condition of the dollar, let us explore how it reacted under a bullish condition.
From July 2014 to March 2015, the DXY moved from ~80 to ~100. This was about a 25% rise. During the same time period, EMLC fell from ~49 to ~39. This was about a 20% fall. The negative correlation is clear.
The idea from the beginning was to exhibit a bearish dollar play via emerging market assets. Government bonds were chosen as a safeguard to potential economic slowdown and as the end route for “yield seekers.”
Essentially, the world economy is slowing. This is shown below in the JPMorgan Global Manufacturing PMI.
This means that emerging market equities may still be at risk due to economic slowdown taking more toll on emerging market company profits.
The second reason for the choice of emerging market bonds over emerging market equities is that this fund (EMLC) currently averages over a 6% interest rate between all of the ETF’s underlying bond holdings. The high interest rate of emerging market bonds is due to the extra risk associated with emerging market assets, but investors will be more willing to take on this risk as alternative options dissipate. This dissipation of alternatives is occurring as we now have over $13 trillion in negative yielding debt in the world. This comprises 24% of the total global investment-grade bond market.
The bullish case is laid out. I will be entering on a pull back within my technical marker or upon a breakout. I have marked fibonacci lines from the all-time high in 2011 to the bottom in September 2018.
With every trade there are risks. For this trade, it is basically all a dollar story. If the dollar turns up, then this trade will not perform well. This risk is muted though, since the world cannot afford a stronger dollar. More importantly, Trump cannot afford a stronger dollar, therefore the dollar’s upside is limited in my opinion. The reason being is that a stronger dollar will result in a lower U.S. stock market. This is due to the entire world essentially being short dollars.
From April 2018 to August 2018, the dollar (DXY) rose about 8%. This caused, on a lagged-basis, the US Stock market to enter into an official bear market (fell greater than 20%), and also caused the Fed to begin the shift to the “easing bias” due to inability for the US Stock market to handle a stronger dollar.
In conclusion, EMLC could be bought on a pullback below $33 or a breakout above $35. In calculating this position’s total return, do not forget about distributions (interest payments) that will occur in holding this bond ETF.
Should the DXY break out above 99, I would look to close the position.