Markets

Christopher Langner is a markets columnist for Bloomberg Gadfly. He previously covered corporate finance for Bloomberg News, and has written for Reuters/IFR, Forbes, the Wall Street Journal and Mergermarket.

Forget trade wars, protectionism and all the tough talk coming from the Twitter account of President Donald Trump. It hasn't been this safe to own emerging market bonds for a couple of years. Or has it?

The average premium paid on debt included in the Bloomberg Barclays Emerging Market Hard Currency Index dropped to a two-year low on Jan. 18 and has remained around that level.

False Security?
The average premium paid on emerging market debt is near a two-year low
Source: Bloomberg

Similarly, the spread paid for insurance against default on emerging market bonds is hovering near two-year lows. The Markit EM CDS Index is at 238 basis points, a stone's throw away from the two-year low of 226 points it touched on Sept. 22.

Illusion of Safety
Credit-default swaps also suggest investors are sanguine over the prospect of losses
Source: Bloomberg

The problem is that both moves may be explained by a technical issue that has little to do with the actual risk of defaults or losses.

Consider that on Jan. 10, Moody's Investor Services said it took 10 negative rating actions in 2016 on Asia-Pacific sovereigns and only one that was positive. Normally, weakening credit scores should translate into higher premiums on both bonds and CDS.

Treasury yields, however, have risen so fast since the election of Trump that less liquid emerging market bonds haven't been able to follow. Premiums have been squeezed, therefore, not because investors perceived less risk in the asset class, but because they couldn't sell fast enough.

Spreads on dollar bonds and CDS tend to move in tandem. As premiums dropped, so did the insurance contracts. Again, this is more of a technical phenomenon than a reflection of reduced risk.

That means double trouble could be ahead for emerging market investors. The median forecast of analysts surveyed by Bloomberg has the yield on the benchmark 10-year U.S. Treasury at 2.75 percent at the end of the year, 32 basis points higher than the current 2.43 percent.

Emerging Trouble
Rising U.S. Treasury yields threaten to cause pain for investors in developing nation bonds
Source: Bloomberg

Meanwhile, emerging market spreads averaged around 348 basis points over the past two years, 75 basis points higher than current levels.

If Treasury yields continue to rise and the premiums on developing world bonds go back to normal, the first year of the Trump presidency could be painful for emerging market debt investors.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Christopher Langner in Singapore at clangner@bloomberg.net

To contact the editor responsible for this story:
Matthew Brooker at mbrooker1@bloomberg.net