BlackRock to JPMorgan See Deeper Emerging-Market Losses
Wall Street’s biggest firms are predicting intensifying bond losses in emerging markets, where borrowing costs have already soared to the highest in more than four years versus U.S. corporate debt, as the Federal Reserve considers curtailing record stimulus.
“We’re not yet convinced that we’ve seen the worst in terms of flows out of emerging markets,” Jeffrey Rosenberg, the chief investment strategist in fixed-income at New York-based BlackRock Inc. (BLK), the world’s largest asset manager, said in a telephone interview, expressing his own views. “We see a lot of valuation change but we see the potential for even more valuation change.”
Investors have yanked $22.1 billion from emerging-market bond funds since the end of April, almost five times the amount pulled from U.S. corporate credit, according to EPFR Global. That’s pushed the extra yield that buyers now demand to own dollar-denominated emerging-market debt instead of U.S. company notes to 1.4 percentage points, about the most since December 2008.
Borrowing costs are soaring from record lows reached in January as speculation deepens that the Fed will curtail its so-called quantitative easing as soon as this month, signaling an end to the flood of cheap money that's propped up asset prices from India to China and Indonesia. The exodus from developing nations began after Fed Chairman Ben S. Bernanke told Congress on May 22 that the central bank could scale back the pace of its $85 billion of purchases of mortgage bonds and Treasuries if the U.S. economy showed sustained improvement.
Emerging-market debt has lost 7.9 percent since the end of April, versus a 5.1 percent decline on U.S. corporates, Bank of America Merrill Lynch index data show. While an expansion in the world’s biggest economy is accelerating, growth in China is projected to slow to 7.5 percent this year from as high as 14.2 percent in 2007, according to 53 economists surveyed by Bloomberg.
“Given the likelihood of further rate volatility and an uncertain emerging-markets growth outlook, we maintain our defensive view” on corporates from developing countries, analysts led by Eric Beinstein in New York at JPMorgan Chase & Co. (JPM), the world’s largest underwriter of corporate bonds, wrote in a Sept. 5 report.
Elsewhere in credit markets, the cost of protecting corporate debt from default in the U.S. declined, with the Markit CDX North American Investment Grade Index, which investors use to hedge against losses or to speculate on creditworthiness, decreasing 2.3 basis points to a mid-price of 79.6 basis points as of 11:38 a.m. in New York, according to prices compiled by Bloomberg.
That’s the lowest level on an intraday basis since Aug. 27 for the measure, which typically falls as investor confidence improves and rises as it deteriorates. Credit-default swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million of debt.
The U.S. two-year interest-rate swap spread, a measure of debt market stress, fell 0.92 basis point to 14.88 basis points as of 11:40 a.m. in New York. The gauge narrows when investors favor assets such as company debentures and widens when they seek the perceived safety of government securities.
Bonds of Ford Motor Co. are the most actively traded dollar-denominated corporate securities by dealers today, accounting for 3.3 percent of the volume of dealer trades of $1 million or more as of 11:42 a.m. in New York, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.
Following average annual returns of 15.3 percent in the four years ended last December, dollar-denominated emerging markets notes have lost 6.8 percent this year, according to Bank of America Merrill Lynch index data. That compares with a 2.9 percent loss in 2013 on the Bank of America Merrill Lynch U.S. Corporate & High Yield index.
“Developed markets paper has held in much better than emerging markets paper,” said Stephen Antczak, the head of U.S. credit strategy at New York-based Citigroup Inc. (C), the second-biggest underwriter of emerging-market bonds. “What worries me is if you don’t have this natural support in place, you could get a disproportionate selloff in emerging markets.”
Investors are withdrawing more cash from developing nations’ bonds after pouring $58.8 billion last year into funds that buy the debt, EPFR data show. Emerging-market debt was seen as a haven with higher-yielding securities amid a U.S. stimulus program that’s funneled more than $2.6 trillion into the financial system since September 2008.
Yields on the Bank of America Merrill Lynch U.S. Emerging Markets External Debt Sovereign and Corporate Plus index have climbed to 5.73 percent after reaching an all-time low of 4.04 percent on Jan. 24.
The gap in yields with U.S. company debt widened to as much as 1.44 percentage points on Aug. 31, the most since reaching 1.47 percentage points on Dec. 1, 2008.
The $22.1 billion of outflows from emerging-market debt funds in the past four months compare with $4.6 billion of withdrawals from U.S. corporate bond funds, EPFR data show.
Asian economies have been among the hardest hit. A JPMorgan index of Indian dollar-denominated bond yields touched 6.525 percent on Sept. 5, the highest since January, with BNP Paribas SA forecasting economic growth of 3.7 percent through next March, compared with a 10-year average of about 8 percent.
India is “one country we’re completely avoiding and have been doing so for 12 months,” said Hayden Briscoe, a Hong Kong-based director of Asia-Pacific fixed-income at AllianceBernstein Hong Kong Ltd.
The U.S., which plunged into a recession five years ago as spiraling home values prompted a credit seizure, will probably grow by 2.7 percent next year and 3 percent in 2015 from 1.6 percent this year, a Bloomberg survey of 73 economists shows.
With the Fed expected to start decreasing its bond-buying program at its Sept. 17-18 meeting, borrowing costs have climbed for bonds globally. Yields on 10-year Treasuries (USGG10YR) reached 2.99 percent on Sept. 5, the highest since July 2011.
The underperformance of emerging-market debt relative to U.S. corporate notes has been sustained for one of the longest periods in history, the JPMorgan analysts wrote in their report.
“When underperformance causes a selloff in the market and liquidity worsens as a result, you have a huge gapping in risk valuation,” said Edwin Chan, the head of credit research at UBS AG in Hong Kong.
While the rout may eventually present a buying opportunity -- Mark McCombe, BlackRock’s Asia-Pacific chairman, talking to Bloomberg TV today, said China’s economy is stabilizing and he’s “pretty positive on it” -- losses for emerging markets debt have the potential to accelerate, BlackRock’s Rosenberg said.
“Emerging markets risk has gone up more than the risk associated with U.S. corporates,” Rosenberg said. “We’re not yet ready to say it’s time to pile into emerging markets.”
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