Outflows pressure EM prices as feedback loop worsens
The rally in emerging market bonds that began in mid-November could come to an abrupt end this quarter as slowing economic growth, corporate debt defaults and continued dislocation in core markets savages the asset class, analysts said this week.
"More supportive technicals, including oversold positions, high cash flows, and a cessation of outflows, have contributed to the past month’s rapid yet arguably unsustainable rally, allowing EM sovereigns to tap the international capital markets, raising $6.5bn over the past month," said Joyce Chang, head of emerging markets strategy at JP Morgan. As the US banking meltdown shows no sign of abating emerging bonds have whittled down December’s gains. Over the past week, spreads for the EMBIG have widened by 40bp to reach 725bp.
"The slowing pace of redemption requests" and "cheapness of some cash bonds" contributed to the rally rather than a renewed enthusiasm for credit risk, argued Kieran Curtis, fund manager of around $750 million in two emerging market debt Sicavs for Morley, the fund management arm of UK-based pensions and insurance firm Aviva.
Despite global monetary and fiscal action, negative feedback loops from the financial world to the real economy is surging and markets continue to be surprised by the flurry of negative data. This suggests that the market is not pricing in a fundamental deterioration in global economic conditions or the realisation that policy stimulus measures will not take meaningful effect until the second half of the year, said analysts.
RBC Capital Markets echoed these concerns, predicting $50bn to $100bn bond and equity portfolio outflows from emerging markets this year. This contrasts with annual inflows over the past four years that have averaged around $450bn. "This collapse in EM inflows will undeniably carry very negative implications for EM growth prospects at a time when access to funding is already scarce," RBC said. It has reduced 2009 growth estimates, predicting Russian expansion at 0.5%, Brazil at 1%, Turkey at 0.5% and Mexico contracting by 2%.
Chang expects more firms will start to break debt covenants this quarter. Arantes, the Brazilian beef exporter, filed for bankruptcy this week after missing a scheduled $8m interest payment of its $150m 2013 notes in December.
The company was caught by huge losses on derivatives. Nevertheless, dedicated EM fund managers currently hold an estimated $12.5bn in cash and so are in a stronger position to support bond prices than the beleaguered hedge fund industry. There will also be an estimated $50bn of coupons and debt amortisation payments this year helping cashflows.
However, the difficulty of rolling over private sector debt amid the global liquidity drought will also drag down bond prices. This week Henrique Meirelles, the Brazilian central bank governor, announced a $20bn credit line to help domestic companies to roll over foreign debt that matures at the end of year. S&P estimates the Brazilian private sector has a total $61.6bn of foreign debt due this year. Borrowing efforts are constrained by reduced credit lines from banks, the international primary market shutdown and the real’s depreciation against the dollar. The central banker said it has not accessed the $30 billion in swap lines the Federal Reserve offered on October 30. The arrangement will be in place till April 30th. The IMF estimates an extra $150m is needed over the next two years to replenish its $200bn lending capacity after spending around $50bn on country bailouts over the past couple of months.
This week’s global market volatility highlights how the recent supply of sovereign paper may not pave the way for high-quality companies to launch new deals anytime soon since recent issues are trading below their fixed reoffer prices. Peru registered with the SEC on Tuesday to obtain regulatory approval for an international bond. The debt management office was hoping in December for a 30-year benchmark to boost the liquidity in the long end of its benchmark but after investor feedback, a 10-year deal up to $600m is now more likely, said bankers. One US investor who participated in Mexican, Brazilian and Colombian bonds issued over the last two months said: "I do not have the appetite for a 30-year deal. It is far too dangerous in this uncertain and illiquid environment".
Bankers are fearful that the primary market window could be still be shut for price-sensitive corporates with no government-backed corporate names willing to test the waters. This week’s analyst predictions that secondary spreads are likely to soften over the coming months suggests issuers need to seize the moment.
* Ecuador plans to make a $31m coupon payment on its 9.375% global 2015 bond due next month in an unexpected U-turn after the country defaulted on its 2012 notes in December.
The government said the $650m 2015 notes are legally different from the "usurious" 12% 2012 and 10% 2030 bonds on which it defaulted. Nevertheless, the government will buy back up to $3.2bn in the 2012 and 2030 global bonds with a steep haircut when it reveals its restructuring plans in the coming weeks.
The decision to pay the coupon on the 2015 bond is an attempt to reduce the size of the buyback on the 2012s and 2030s that may be restructured with a haircut of 30 cents on the dollar, said one New York-based banker.
In addition, "there is also talk that Venezuela may be holding a fair amount of 2015s, an issue that could have had some influence in the decision to continue paying the 2015s," concluded Alberto Bernal, head of macroeconomic strategy at Miami-based Bulltick Capital Partners.