|TRADEIDEA25/06/20191FOCUS|EM24June2019EM:LookatsystemicfactorsandseethefutureKEYMESSAGESOurPCAmonitorshowsthattherallyinEMlocalcurrencyratesandsovereigncredithasbeendrivenalmostentirelybysystemicforces.UScorporatecredit,2yearUSrealrates,andthemeltdownoftheUSandEuropean5yand10yrateshavebeenthemostimportantdrivers,ourmodelsshow.Animportantobservationisthatsystemicdynamicsprevail.NinetypercentoftheweeklyvariabilityofEMlocalcurrencyratesandsovereigncreditisexplainedbythefirsttwocommonlatentfactors.Althoughthesourcesofvariabilitymaychangeamongcountries,theresultsshowthattheseassetsmoveinasynchronisedmanner.Asexpected,thecountrywiththemostidiosyncraticcomponenthasbeenTurkey.WeexpectstructurallylowerrealinterestratesintheUStobodewellforEM.Ceterisparibus,wecontinuetoseelowsystemicriskfortheassetclassgoingforward.Wereinforceourbullishcallforemergingmarkets.PleaserefertoimportantinformationandattheendofthisreportEMSTRATEGYGabrielGersztein,GlobalHeadofEmergingMarketsStrategy|BancoBNPParibasBrasilPrincipalcomponentforEM–howitworksWeanalysetherelationshipsbetweenasetofemergingmarket(EM)sovereigncreditandexternalcommonfactorsbyusingPrincipalComponentAnalysis(PCA).ThisapproachhelpsustocategorisethefactorsthathavebeendrivingthevariabilityinEMIRandsovereigncredit.Forward-lookingscenarioscanthenbeconstructedforthesedriverstoassessthetheoreticalmarketimpactofsuddenchangesintheirtrends.Weuseatwo-stepprocedure.Thefirststepistoextractthetwomostimportantcommonlatentfactorsfromthesedataseries.Inthesecond,wecalculatetheco-variancebetween(a)thesefactorsand(b)potentialexplanatoryvariables.Ourapproachusesa35-weeklyrollingwindowtocalculatetheprincipalcomponentsfromabasketofEMsovereigncredit.Thisbasketincludesthe5yCDSofthemostrelevantandliquidEMs:Brazil,Mexico,Colombia,SouthAfrica,Turkey,Indonesia,Russia,Chile,Philippines,MalaysiaandArgentina.Forinterestrates,thebasketincludesthe5ylocalcurrencyswapratefromsomeofthemostrelevantEMcountries:Brazil,Mexico,Colombia,SouthAfrica,Turkey,Indonesia,S...
