Financial markets haven’t set too many records so far in 2023. One exception is emerging markets debt.
You heard that right. Emerging market nations placed $39 billion in bonds during the first two weeks of this year, nearly half the total for all of 2022. Investors lapped them up. Mexico, for example, issued $2.75 billion in 12-year paper at a 6.35% interest rate on Jan. 3. The yield has slid to 5.5%, meaning the bonds are trading at 106% of par, reports Samy Muaddi, portfolio manager of the emerging markets bond strategy at T. Rowe Price.
Quick killings like that may be harder to find going forward, though. Emerging markets have magnified a global bond rally that started three months ago, as investors start to see light at the end of the tunnel of inflation and rate hikes to quell it. The
iShares J.P. Morgan USD Emerging Markets Bond
exchange-traded fund (ticker: EMB) has climbed 14% from a late October trough.
Taking an index view, there’s still room to run, argues Sergey Goncharov, a portfolio manager for emerging markets bonds at
Vontobel Asset Management.
Average spreads for emerging market sovereigns over U.S. Treasuries, which move inversely to prices, have compressed from 5.8 percentage points, or 580 basis points, to 440. That’s still a ways off their post-Covid record of 330 basis points. “Now that interest rates have more or less stabilized, conditions are perfect for EM issuers who were frozen out of the primary market last year,” he says.
Cem Karacadag, head of the emerging markets sovereign debt group at Barings, runs his numbers differently. Average spreads across the index are distorted by a handful of basket cases like Argentina and Ghana, which trade at yields well into double digits, he says. The market rebound so far has centered on relative blue-chip governments with investment grade credit ratings, BBB or better on the Standard & Poor’s scale. Saudi Arabia, Hungary and Indonesia are among Mexico’s peers in this category.
Investment-grade sovereign spreads are less than 20 basis points wider than prepandemic levels, which Karacadag chooses for a benchmark. “There’s not a lot of the low-hanging fruit left,” he concludes.
Action is shifting now to sovereigns with a BB rating, the strongest tier of high-yield bonds. Colombia and Serbia, both in this category, announced 10-year dollar-denominated issues within the past week, paying 7.6% and 6.8% a year, respectively. If those fly with investors, there’s a lot more where they came from.
Muaddi is expecting a stream of BB issues once Chinese investors, who have become an important part of the global pool, get back from their New Year holiday. Potential candidates include Morocco, Ivory Coast and the Dominican Republic. Goncharov is watching Latin American state-owned oil companies, Brazil’s
(PBR) and Mexico’s Pemex, BB-grade “quasi-sovereigns” that are always hungry for financing. “The higher quality end of high-yield is within the line of sight,” Muaddi says.
Central and Eastern Europe may offer particular pockets of value, thinks David Doggett, senior global trader for emerging markets debt at Morgan Stanley Investment Management. Investors fled the region last year, fearing spillover from the war in Ukraine and fiscal impacts from Russia’s squeeze on natural gas exports. They may still be overestimating risks. Romania, which clings to investment grade with a BBB- rating, had to pay a junk-like 7.22% for a 10-year bond issue this month. “Romania continues to be very wide,” Doggett says. “You could see some re-rating across CEE.”
The year to come may see some defaults or restructurings in emerging market sovereign credit, too. Six to 10 countries are “on the border” of such an abyss, Muaddi estimates, Ghana being the biggest in market terms. These are usual suspects by now, whose distress is unlikely to cause contagion across the asset class. “All these stories are idiosyncratic,” Barings’ Karacadag agrees. “The market has gotten a lot better at discriminating between issuers.”
Fruit may be hanging higher than a few months ago in emerging market bonds. But at the rates on offer, investors won’t keep passing by.