After a torrid 18 months, EM bond markets appear to have something resembling a spring in their step. With the Fed finally pausing its rates cycle this week, some have decided that enough’s enough, it’s time for a rally, prospects of the further 50bp increase that the dot plot is indicating be damned.
Syndicate bankers are reporting more mandates — even in the almost entirely dormant world of Latin American corporates — as issuers gain confidence that there’s some stability out there in the rates market. Some investors are talking about a potential return for credits that were almost distressed just months ago, with Nigeria’s market-friendly decision to let its currency float having earned praise from analysts.
But EM syndicate bankers have felt excited about the pipeline on several occasions over the past year, only to be disappointed when another window slips by with minimal activity.
Part of the problem is that secondary market levels, which investors say are as illiquid as they’ve ever been in EM, are unreliable. It’s an open secret that quotes on bond prices, especially beyond the sovereigns, quasis and blue chips that have made up most of recent issuance, are often jumping around based on very little meaningful trading.
With a nervous investor base, it’s hard for deals to get marked much higher. But — as has been seen in the curves of several struggling Latin American corporates, in particular — the merest sign of bad news can see bonds marked down 10 or 15 points in a day.
It creates a vision of a broad-based credit crunch for high yield borrowers, and undoubtedly there is a host of low-rated issuers that simply would not be able to raise funding in bond markets. But there are plenty of borrowers, particularly in the lower investment-grade or higher double-B bracket of EM, that probably do have access yet still shy away — largely as secondary market levels suggest they would have to do so at unappealing levels.
This is a vicious cycle. With no signs of a rally any time soon, and no proof that these issuers will regain market access, there’s little incentive for investors to start playing. Even if a bond does suddenly look irresistibly cheap, it is hard to source an amount that would make the investment worthwhile for a major institutional player.
Usually, adding supply to a weak market would compound the pain. Here, it would be likely to have the opposite effect.
Firstly, new deals force investors to engage with issuers. If all their competitors are picking up a bargain in great size thanks to a chunky new issue concession, a portfolio manager has no choice but to at least take a look. And then FOMO takes over: you cannot afford to miss out on a deal ripping tighter in secondary, as would be likely if a suddenly liquid new bond appeared on the scene.
Moreover, in the secondary market big investors simply can’t acquire bonds in the size they need. A new issue offers the chance to put $100m or more to work in one go. Once the big players in the asset class are doing that it’s far easier for broader conviction to grow and secondary levels can quickly reprice.
And, of course, once it becomes clear that bond markets are open to a broader range of issuers, investors will be less concerned about refinancing risk — further supporting spreads.
Sure, an excess of supply would eventually weigh on spreads, but EM bonds are a long way from that. Right now, the asset class needs supply to generate demand. Let’s hope that the bullish syndicate bankers are right, for everyone’s sake.