Emerging-Markets Mania Threatens to Burn Out
It's hard to overstate the amount of money that has been rushing into the debt of developing nations.
The biggest exchange-traded fund focused on emerging-markets bonds has almost doubled its assets this year, data compiled by Bloomberg show.
Dollar-denominated debt of developing economies is poised for its best annual return since 2009.
Yields on the debt have dropped to the lowest in more than three years.
The good news for this rally is that cash just keeps pouring in, fueling some momentum, at least for the time being. After all, where else can investors go to earn some income on their debt investments? Yields in developed markets are hovering near record lows or setting new ones, forcing bond buyers to get more creative if they want to earn any income at all.
The bad news is that the main rationale for buying emerging-markets debt is quickly becoming obsolete. These bonds have rallied so sharply that, in several cases, they're not offering that much more yield compared with similarly rated developed-market debt.
Consider, for example, dollar-denominated junk-rated debt of emerging markets companies. Investors are demanding the smallest premium to own these notes relative to similarly-rated U.S. ones since 2013, according to Bank of America Merrill Lynch index data.
And, of course, there's the slight problem of fundamentals, which aren't improving much for countries that have benefited the most from this year's rally. The biggest winner, for example, is debt of Brazil, which is mired in its worst recession in decades. A close runner-up is debt of Venezuela, where residents are forced to wait in seemingly endless lines for a chance to get food and pharmaceuticals, sometimes to no avail.
Yet another potential dark cloud is a solid U.S. economy. Last week's positive jobs report has some analysts predicting that the Federal Reserve will raise rates sooner than the market is expecting. That would bode poorly for developing-markets debt, which has become increasingly vulnerable to U.S. policy shifts.
Meanwhile, companies in developing nations are selling bonds at a near-record pace, with $39.6 billion of such sales last month, CreditSights data show. This adds to the more than $18 trillion of emerging-markets corporate debt outstanding, an amount that has more than quadrupled since 2004, IMF data show.
Longer term, the growth in emerging-markets sovereign and corporate debt may prove to be somewhat problematic, potentially exacerbating any hiccups in the global economy. The longer this hot money flows into emerging markets, the more vulnerable the nations' debt looks.
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