Fears of bubble in EM debt grow

Fears are growing of a bubble in emerging market debt as record lower-rated issuance and unstoppable capital inflows dominate the market.

As yesterday’s Emerging Markets reported, high-yield bond issuance in Asia so far this year has already trebled the full-year total for 2012 to meet the demands of investors hungry for yield.

This ardour, though, is worrying some investors who fear a bubble in emerging market (EM) debt. “I’m told Ukraine has seen the issuance of 10 corporate dollar bonds so far this year, Rwanda’s 10-year debut bond came in below 7% yield despite its single B rating, and Nigeria’s 2021 dollar bond yields 4%,” said Charles Robertson, global chief economist at Renaissance Capital. “What we are now getting very close to is a local currency bond bubble too.”

For example, Robertson said that local bond flows into Turkey were $223 million in January to February 2012, and in January to February 2013, $4.53 billion – a 20-fold increase in a year. Russian foreign ownership of the local bond market had boomed from almost nothing to 15% within a year, he added, while the yield on the local 10-year bond had dropped to 6.7% in a country with headline inflation at around 7%. “But foreign ownership [in Russia] could double again,” he said.

Debt capital market bankers in Asia are split over their views on a market bubble. “What constitutes a bubble?” said one. “Unreasonable valuations and excessive speculative capital? I wouldn’t say I see evidence of that.”

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But others disagreed. “I think there is a risk, certainly,” said Rogerio Bernardo, director on the bond syndicate desk at RBS, highlighting the potential of a change in the outlook for rates. “If US Treasury yields start to rise it will put a lot of pressure on fixed-income funds and hurt a lot of portfolios. The bubble is certainly there and we could see a rapid shift away from fixed income assets if base rates are rising.”

A separate RBS report, authored by analyst Erik Lueth, argued last month that emerging market 10-year sovereign bonds were overvalued by 5% on average.

In a recent note to clients, Capital Economics economist Paul Hollingsworth said he expected renewed pressure on dollar-denominated emerging market government bonds because they were vulnerable to a curbing of quantitative easing, concerns about valuations, and increasingly fragile outlooks for near-term economic growth in emerging markets. But he added: “Despite these three factors, we don’t expect any sell-off in dollar denominated EM bonds to be dramatic.”


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