Global Macro Rules: Commodities, Risk Aversion, and US High Yield
In Part 1, we covered how US rates and the dollar cycle drive emerging markets. Now we get to the rest of the global macro toolkit: commodities, the VIX, and a sleeper driver that most people underrate: US high yield spreads.
The punchline is the same as Part 1. EM assets are at the mercy of global forces. But the details here get more interesting, and some of them are genuinely counterintuitive.
Commodities: Latam Produces, Asia Consumes
Commodities matter a lot for EM. That much is obvious. But why they matter is worth thinking about.
A huge chunk of EM countries, especially those in the main credit indexes, are commodity exporters. That’s not a coincidence. Countries that export commodities earn USD revenue. That gives them a natural hedge when they borrow in dollars. It’s easier for them to get access to external debt markets. So the EM universe is skewed toward commodity producers by design, not by accident.
There’s also the old “resource curse” argument. The idea that commodity wealth holds back development through Dutch disease or rent-seeking. But the authors point out that Canada, Australia, New Zealand, and Norway all got very wealthy while being commodity-rich. So that theory doesn’t hold up as well as people think.
The regional split is clean. Latam produces commodities. Asia consumes them. Brazil has iron ore and soy. Chile has copper. Peru has copper and gold. Colombia and Russia have energy. On the other side, China, Korea, India, and most of Southeast Asia are net importers of energy and metals.
This gives you a straightforward trading rule: when you’re bullish on commodities, overweight Latam FX and underweight Asia FX.
The authors test this with their usual perfect-foresight framework. If you could perfectly predict whether commodities would go up or down each month, and rotated between Latam and Asia accordingly, you’d generate massive alpha. The strategy really came alive after 2008. Even a small edge in forecasting commodity direction translates into meaningful outperformance.
But here’s what’s important. This is a relative value trade. You’re going long one region versus another. You’re not just betting on commodities going up and hoping all of EM benefits. That matters because the relationship between commodities and the broad dollar has gotten less reliable over time.
The Median EM Country: Softs Exporter, Energy Importer
When you zoom into the actual commodity exposures country by country, the picture gets more nuanced. The median EM country is a big exporter of food (softs), a tiny net exporter of minerals and metals, and a big net importer of energy.
Russia is the wild outlier. Its net energy exports were 10.4% of GDP. Colombia and Malaysia are also meaningful energy exporters. On the import side, Thailand, Singapore, and Korea are the most energy-dependent, all running energy import bills of 3-4% of GDP or more.
Chile’s mineral exports (copper) were 7.6% of GDP. Peru’s were 6.4%. South Africa had 2.9% from gold and platinum. Argentina was the softs champion at 5.6% of GDP.
This granularity matters because not all commodity rallies are the same. An oil rally is very different from a copper rally, which is very different from a food price spike. The broad commodity index is a useful starting point, but you really want to know which specific commodities hit which specific countries.
Oil Importers Also Like Higher Oil (Wait, What?)
This is one of the more counterintuitive findings in the chapter. You’d think that countries that import oil would see their currencies weaken when oil prices go up. More expensive imports, wider current account deficits, more pressure on the currency. Makes sense, right?
But that’s not what the data shows. Virtually all EM currencies strengthen when oil prices rise. Yes, even the oil importers. The importers strengthen less than the exporters, obviously. But they still strengthen rather than weaken.
Two things explain this.
First, higher commodity prices usually mean higher global growth. And higher global growth is good for EM broadly. Even if Turkey is paying more for its oil imports, the overall global environment is better, and capital flows into EM increase. There’s actually a specific explanation for Turkey: for every dollar Turkey’s current account loses to higher oil prices, its capital account gains more than a dollar, because petrodollars from Gulf countries flood in.
Second, higher commodity prices have historically been associated with a weaker USD. This relationship isn’t as airtight as people assume (more on that below), but on average it holds. The reasons: commodities are priced in USD (translation effect), the ECB tends to react more aggressively to headline inflation than the Fed does (making EUR relatively more attractive), and oil producers recycle their petrodollars into EUR-denominated assets.
The practical takeaway: don’t buy USD against oil importers when you expect oil to rise. Express your oil view in relative value terms instead.
The Dollar-Commodity Link: Still There, But Fading
Historically, the US broad dollar and commodity prices have been highly correlated. Dollar down, commodities up. Dollar up, commodities down.
But the authors flag that this correlation may not be as stable going forward. The QE era turbocharged this relationship, and as QE faded, so did some of the tightness of the correlation. And there’s a structural shift: the US has become an energy exporter thanks to the shale revolution. That makes the USD itself a “petro currency” to some degree, which weakens the old negative correlation between the dollar and oil.
This is another reason the authors keep coming back to relative value. Instead of going long EMFX against the USD when you’re bullish on commodities, express the view across regions. Long Latam versus short Asia. That way you don’t need the dollar-commodity link to work perfectly.
Risk Aversion (VIX): Worse for FX and Credit Than for Rates
Everyone knows EM trades poorly when the VIX spikes. But the authors break down exactly how different EM asset classes respond, and the differences are significant.
EM credit gets hit the hardest by rising risk aversion. The beta is consistently negative. This makes sense because EM credit inherently contains a US credit component, and US credit also trades poorly when VIX rises.
EMFX is close behind. It also trades poorly during risk-off, though it occasionally manages to decouple from the VIX in ways that EM credit rarely does.
EM rates are the surprise. The beta of EM rates to VIX broadly fluctuates around zero, with only a slightly negative median. That’s because EM rates have a big US Treasury component, and Treasuries rally during risk-off. The UST tailwind partially offsets the EM-specific pain.
No EM Currency Can Escape Risk Aversion
Here’s a fact that should humble anyone who thinks fundamentals can protect you during a panic. Not a single EM currency has a consistently positive return during periods of rising risk aversion. Not one.
And this includes countries with rock-solid external positions. Singapore has a net investment position of +248% of GDP and a current account surplus of nearly 19%. South Korea is a net creditor. Israel runs a surplus. You’d think these currencies might behave like the Japanese yen, strengthening during crises as domestic investors repatriate money.
Nope. Even SGD, KRW, and ILS weaken when VIX rises. The USD bid during risk aversion is just too broad for any EM currency to fight against. The only currency that comes close to decoupling from VIX is the Chinese yuan, and that’s only because the PBOC actively manages it.
Negative EMFX Beta to VIX = Warning Sign
The beta of EMFX to VIX usually sits solidly in negative territory (meaning EMFX weakens when VIX rises, as expected). But in late 2017, something unusual happened: EMFX started ignoring rising VIX. The beta flipped close to zero or even slightly positive.
That should have scared people. And it did, at least in hindsight. 2018 brought a meaningful sell-off in EMFX.
The same pattern showed up in the DXY. In early to mid 2008, the dollar’s beta to VIX turned negative (dollar weakening during risk-off). That didn’t last. The second half of 2008 brought one of the strongest USD rallies in history.
The rule: when EMFX or the dollar stops reacting normally to VIX, prepare for the usual relationship to snap back. And probably violently.
Avoiding EM Rates During Rising VIX Doesn’t Actually Help
This is one of the more surprising findings. You’d think that cutting your EM rates exposure whenever VIX rises would be smart risk management. The authors test this with perfect foresight (meaning they know in advance whether VIX will go up or down each month).
The result? Just owning the GBI-EM index outright would have beaten the VIX-timing strategy. The information ratio for the plain index was 1.6, versus 1.4 for the VIX-based approach.
The VIX strategy did well during the big blowups in 2008 and 2013. But it underperformed badly during the long stretches of calm from 2004-2007 and 2010-2013. Small moves higher in VIX just aren’t negative enough for EM rates to justify cutting exposure.
The takeaway: align your EM rates view with your US rates view, not with your VIX view. Only cut EM duration if you expect a truly massive spike in risk aversion. And those are rare and basically impossible to predict.
US High Yield: The Most Underrated EM Driver
The last global macro driver the authors examine is US high yield credit. And honestly, this might be the most interesting section of the chapter.
Rising US HY spreads negatively impact all EM asset classes. That includes EM credit (obviously), EMFX, and even EM rates.
The impact on EM credit and EMFX is roughly equal in magnitude. That alone is surprising because you’d expect credit-to-credit contagion to dominate. But the beta of US HY returns to EMFX returns is basically the same as the beta to EM credit returns.
The impact on EM rates is more subtle. The beta is lower but still consistently positive. This is somewhat counterintuitive: wider US credit spreads usually mean lower US rates, which should be good for EM rates. But the negative credit impulse dominates. A truly negative beta (where wider US HY spreads are good for EM rates) is extremely rare.
The authors flag two specific episodes where the US HY to EM relationship spiked: 2006 and 2014. The 2014 episode was driven by the oil collapse. Oil prices crashed, US HY spreads blew out (because US shale companies had issued tons of high yield debt), and EM got caught in the crossfire. EMFX weakened, which then spilled over into EM rates.
And here’s the structural point: the US shale boom means US HY will likely remain more sensitive to oil prices going forward than it was historically. All those shale companies borrowing in the HY market created a permanent link between oil and US credit conditions. Which means the correlation between US HY and EM assets is probably structurally higher now.
Rising US HY spreads are actually more damaging for EM than a rising VIX or a falling S&P 500. That’s a statement worth sitting with. When people think about risk-off indicators, they usually look at the VIX or equities. But if you’re trading EM, you should be watching US HY spreads more closely.
The Chapter’s Summary (In Their Words, Simplified)
The authors wrap up Chapter 2 with a clean set of rules:
- 65% of EM returns on an index level come from global macro. Only local rates are mostly driven by local factors.
- When bullish on US rates, add EM duration. EM rates track US rates on average.
- Commodity views should be expressed in relative value. Long Latam vs short Asia when bullish on commodities.
- All EM currencies benefit from higher commodity prices, not just commodity exporters. Don’t short oil importers when oil is rising.
- During rising risk aversion, avoid EMFX. No EM currency can reliably decouple from VIX.
- Negative EMFX beta to VIX is a warning sign. The old relationship will reassert itself.
- Don’t cut EM rates just because VIX is rising. It doesn’t add alpha unless the VIX spike is truly massive.
- Watch US HY spreads. Rising HY spreads are worse for EM than rising VIX. They hit all EM asset classes, including rates.
- Lagged reactions create opportunities. When macro changes direction, EM assets sometimes take time to adjust. That’s where the alpha is.
The overall picture from Chapters 1 and 2 is pretty clear. EM assets are boats on the global macro sea. The weather comes from Washington (Fed policy), from the dollar, from commodity markets, and from US credit conditions. Individual country fundamentals matter, but they matter less than most people think. And nobody is safe when the storm comes.
Book Details:
- Title: Trading Fixed Income and FX in Emerging Markets
- Authors: Dirk Willer, Ram Bala Chandran, Kenneth Lam
- Publisher: Wiley
- Year: 2020
- ISBN: 978-1-119-59905-0