One of the points we have emphasized to clients in the past two months is that many of our indicators suggest that long rates in the US may not rise as aggressively as the consensus expects. In other words, the Fed might stay more dovish than the market expects and tapering, should it occur, is already priced in.

In this respect it is interesting to ponder the following chart which shows the z-score of global rates relative to their historical spread to the US 10y rate.

(click on pictures for better viewing)

171213_zscore 10y rae

Indian and South African bonds look cheap relative to their historical spread to the US 10y note and could benefit if the market is currently overestimating the effect from tapering.   This is an interesting theme to consider in relation to the real effective exchange rates in India and South Africa, which are currently sitting at the lower end of their long-term ranges.

171213_INR and ZAR REER

A lot of things can still go wrong in EM economies, but a lot of pain and bad news already seem to have been priced in.   In particular, it is interesting to note the REER in India which now looks deeply undervalued relative its historical trading range. Finally, we note that the EM-investor darling of choice in 2013, Mexico, currently looks expensive in sovereign bond space.   This offers opportunities in EM space shorting Mexican bonds relative to eg  Indian or South African bonds.