The recent breakdown in the correlation between emerging markets and high yield earlier this spring may contribute to a widening of emerging market spreads in the latter half of the year. Christian Stracke, head of emerging market research at independent research provider CreditSights, noted the collateralized debt obligation bid for high-beta emerging market assets may remain strong in the near term as the asset class is used as a diversification tool. But he added the asset class' high correlation with other risky assets is dependent on generous global liquidity conditions, which may be coming to an end.
"Even if CDOs are suspicious of where correlations are going, they still don't have much of an option and need some diversification in the short term," Stracke explained. That being said, in the long term he expects rating agencies will be forced to reconsider their diversification methodologies to the point where they would lessening the motivation for CDOs to acquire EM paper. As a result of these potentially negative technicals and unfavorable global liquidity conditions. Stracke anticipates EM spreads will back up 50-75bps between now and the end of the year. Macro factors he named include the slowing global economy, uncertainty surrounding the upcoming election cycle in Latin America and summer doldrums.
