EM issuers find hope among chaos
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EM issuers find hope among chaos

A rally in US Treasuries could be a win for emerging market bonds

Ferris wheel and roller coaster, France

For the last 15 years, the fate of the EM debt markets has been glued to the vicissitudes of the US Treasury market. The Silicon Valley Bank affair lies behind the first gyration in a while that could benefit the asset class.

Since the start of the global financial crisis in 2008, EM fund managers have had to understand the politics and economics of every planet and moon in their solar system of credits, and the behaviour of the supernova it orbits — the US Treasury market, the core of which is US Federal Reserve monetary policy.

During the years of quantitative easing, the EM bond market could be gleeful. Provided you didn’t get to buy bonds from, say, a dubiously structured fishing company, or equivalent, you made money. The only gripes were about how much as yields were so low.

But as inflation — exacerbated by Russia’s invasion of Ukraine — gripped the world economy in the pandemic’s wake, forcing central banks to push rates up beginning in 2021, the reaction in the US Treasury market to Fed policy has dictated what can be done in EM bonds, and how much money flows in or out of the asset class.

UST influence

As US Treasury yields climbed ever higher, it became almost impossible to make money investing in EM new issues. No matter how many fishy deals you swam clear of, almost every one would trade lower on the break — not because the credit was bad, but because of the underlying movement in US Treasury prices.

That made 2022 a horror show for EM bonds and, despite a brief hiatus in January when there was hope US inflation had been tamed, this year has not smelled of roses either. Even in January, as overall issuance volumes surged, plenty of high-yielding EM issuers were still locked out of the primary market as the Fed pushed rates up to combat inflation, against the hopes (and, perhaps, magical thinking) of investors that it would stop.

US inflation is still high — 6% according to Tuesday's year-on-year CPI reading — and the Fed has said with consistency that its interest rate policy will depend on such data.

Stability out of confusion?

Nonetheless, US Treasuries rallied as investors scurried for safe-haven assets in the wake of Silicon Valley Bank’s collapse, causing deposit withdrawals from and selling of shares in some regional US banks on Monday, while Credit Suisse was looking more wobbly than usual on Tuesday.

Immediately, the talk of a 50bp rate rise this month looked to have been squashed. First, analysts lined up to say it would now be 25bp, as the Fed reassessed the impact of the US Treasury rally. Goldman Sachs said there would be no change in rates. Nomura stuck its head above the parapet to say it was expecting a 25bp cut.

The rally and the cluelessness over what happens next are not short-term wins for EM issuers. Investors will not put money to work in such volatility. But in the longer term, if this marks an abrupt end to rising rates, even if just for a while, then EM borrowers may benefit from a period of stability.

A change in the rates outlook in US dollars may be just enough to give some of the issuers that have struggled to bring deals a lifeline to financing before the fight against inflation resumes.

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