The tide is turning with a vengeance for emerging-markets debt.
Investors are fleeing funds that focus on the debt, yanking a record $6.6 billion from emerging-markets bond strategies in the week ended Nov. 16, according to EPFR Global data. The debt is poised for its biggest monthly loss since the so-called taper tantrum of 2013, when Federal Reserve Chair Ben Bernanke hinted that the central bank might soon slow its monthly bond purchases and threw markets into a tizzy.
In this case, the debt of developing economies is positioned uniquely for pain, which will most likely intensify in coming weeks. While bonds globally are posting some of the biggest losses on record, debt of U.S., Germany, Japan and other large economies will eventually have natural buyers that can swoop in and support values. That's already happened to some extent with riskier corporate debt in the U.S.
But that's less of the case for emerging markets, which investors flooded into during years of searching for higher yields. Companies in these more-vulnerable economies have $340 billion of debt coming due through 2018, and they are going to have a hard time paying all that back if investors keep withdrawing their cash.
The explanation behind the exodus from something that was the darling of many money managers just months ago is twofold.
After the election of Donald Trump as the next U.S. president, many expect his infrastructure spending programs and trade policies to lead to higher consumer prices in the world's biggest economy. Bonds tend to do poorly when inflation accelerates, especially because such an environment would prompt the Fed to raise benchmark interest rates faster than many expect.
That would bad for all types of debt but particularly for notes in emerging markets. That's because investors will migrate back to higher-rated bonds in developed economies instead of those in less-proven nations.
Also, more U.S. growth typically means a stronger dollar, which is a significant problem for emerging-market nonbank borrowers, which have accumulated more than $3 trillion in dollar-denominated debt, according to Bank for International Settlements data. The higher the dollar rises, the more expensive it becomes to pay back the debt.
And already this week, the currency has surged because of the sudden prospect of tighter Fed policies and faster U.S. growth.
The sheer scale of leverage in the economy, including "the large increase of emerging-market debt, much of it denominated in dollars," is one of the biggest risks in the financial system right now, Adair Turner, former U.K. Financial Services Authority chairman, said in a Bloomberg Television interview Friday. All that money is owed to somebody, and a failure to pay it back will cause big ripple effects.
So as emerging markets come under stress, bond investors around the world should take note. As the dollar continues to strengthen, it's not a stretch to see how this developing-market debt selloff can worsen, having far-reaching consequences on markets around the world.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
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