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Emerging Bond Yields Drop to Record Low in Biggest Rally Since September
Emerging-market bonds are heading for their biggest monthly rally since September, cutting yields to a record low, as accelerating economic growth and Argentina’s debt restructuring spur confidence.
Developing nation bonds rallied 4.3 percent in July, reducing the average yield to 5.89 percent, the lowest since Bloomberg began compiling data from JPMorgan Chase & Co.’s EMBI+ Index in 1998.
Investors are turning to economies the International Monetary Fund said this month will expand three times faster than industrialized nations, with less than half the level of government debt. Indonesia’s bonds jumped 6.1 percent as the finance ministry predicted 6 percent second-half growth, up from 5.8 percent in the first half. Argentine debt rose 13.8 percent as President Cristina Fernandez de Kirchner’s $12.9 billion restructuring sparked a credit-rating upgrade.
“There has been an increased acknowledgement of the shift in the relative vulnerabilities or riskiness between emerging markets and developed markets” given the sovereign debt crisis in western Europe, said Marc Balston, an emerging-market debt strategist at Deutsche Bank AG in London.
Developing economies are set to expand 6.9 percent this year, compared with 2.3 percent growth for advanced economies, the Washington-based IMF said in a July 7 report.
‘Still Very Positive’
The MSCI Emerging Markets Index of stocks has gained 8 percent this month, on track for its biggest advance since March, led by a 13 percent surge in eastern European gauges, the region’s best returns since May 2009. The Czech koruna and Polish zloty have gained more than 10 percent, the world’s best performers against the dollar, on confidence the nations’ biggest market for exports is recovering after Germany’s Ifo institute said last week its business climate index unexpectedly jumped to the highest level since July 2007.
“The outlook is still very positive,” said Phil Langham, a senior emerging markets money manager in London at RBC Global Asset Management, which oversees about $200 billion worldwide. “Emerging markets are pretty well positioned. Balance sheets are still very strong. Valuations are pretty attractive.”
The cost of protecting emerging-market sovereign debt from nonpayment fell worldwide, with the biggest declines for South Korea credit-default swaps, which dropped by 24 percent, Bloomberg data show. South Africa swaps declined by 21 percent and contracts on Russia fell 16 percent.
Stress Tests
The extra yield investors demand from emerging-market debt over U.S. 10-year Treasuries fell 53 basis points this month to 273, JPMorgan indexes show. The spread dropped to as low as 270 basis points on July 27, the narrowest gap since May 13.
Financial markets around the world rebounded in July as governments and central banks moved to reassure investors that Greece, with a budget deficit that ran at 13.6 percent of gross domestic product in 2009, would not default, and as the results of stress tests alleviated concerns about the strength of European banks.
Further gains in emerging market bonds will be led by higher-yielding credits such as Argentina and Venezuela, Balston said.
Fitch Ratings raised Argentina to B, five levels below investment grade, from default on July 12 after the country’s bond swap in June. Argentina has restructured more than 90 percent of bonds on which it suspended payment in 2001, when it defaulted on about $95 billion of debt. Argentina has run a budget surplus before interest payments every month since December 2008. The government expects the economy to grow by at least 6 percent this year.
‘Favorable View’
“We’ve got a favorable view on Argentina,” he said. Balston is also positive on Ukraine’s outlook. The IMF’s board approved a $15.2 billion loan for the country on July 29 after Ukraine agreed to cut its budget deficit.
Indonesia’s budget deficit was equivalent to 1.6 percent of GDP last year compared to a shortfall in the United States of 9.9 percent of GDP in the fiscal year ended Sept. 30.
Low bond yields have spurred record debt sales by emerging markets, at $374 billion so far this year, up from the previous record of $354 billion in the first seven months of 2009, according to data compiled by Bloomberg.
“Spreads can tighten further but the relative attractiveness of the yield is starting to decline,” he said. Further gains in emerging market bond prices will be harder to make, he said.
Change in Direction
The relative strength index of the JPMorgan EMBI+ Composite index of emerging market bonds rose to 88 yesterday, above the 80 level which some traders believe can indicate a change of direction. The relative strength index measures the velocity of change of an index or security.
A sell signal was also triggered for emerging-market stocks after developing-nation equity funds had the second-biggest inflows for the year in the past week, according to Michael Hartnett, BofA-Merrill Lynch Global Research’s chief global equity strategist, citing data from EPFR Global. The last sell signal on April 28 was followed by a 9.2 percent decline in the MSCI Emerging Markets Index the following month.
Peaking inflation in the developing world is removing uncertainty over interest rate policy and feeding stock markets, said Jonathan Garner, Chief Asian and Emerging Market Strategist at Morgan Stanley & Co. in London. Emerging market stocks could rise another 15 percent by the end of the year, he said in an interview July 29.
The People’s Bank of China said on July 30 that it saw little need for an imminent increase in interest rates for the biggest emerging market. Chinese consumer prices rose by 2.9 percent in June from a year earlier. Chinese stocks have rallied 10 percent in July.
“We have started to outperform developed equities again which is something that we thought would happen in the second half of the year,” said Garner, who picked Russia, South Korea and Brazil as his favorite equity markets.
To contact the reporter on this story Jason Webb in London at jwebb25@bloomberg.net.
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