Emerging-Market Bond Anxieties Surging by Most Since 2008

The biggest drop in perceived creditworthiness for emerging-market borrowers since the credit crisis is deepening as speculation intensifies that central banks will scale back record stimulus.

Prices on the Markit CDX Emerging Markets index, a credit-default swaps benchmark for debtor nations from Latin America to the Middle East and Asia, have tumbled 4 cents in the two weeks through yesterday to 107 cents on the dollar. The decline is the biggest since the failure of Lehman Brothers Holdings Inc. reverberated across financial markets and caused the index to plunge 6.7 cents in the period ended Nov. 18, 2008.

Investors who eight weeks ago were willing to lend Rwanda $400 million at an interest rate of 6.625 percent in its first debt offering are now struggling to find any haven as developing countries bear the brunt of the global bond rout. Emerging-market bonds have fallen 6.3 percent since the start of May, almost triple the overall market, as speculation mounts the Federal Reserve will lead policy makers in reducing support to bolster growth as economies from China to Brazil slow.

“There’s nowhere to run and nowhere to hide” from the unwinding of central-bank programs including quantitative easing in the U.S., said Jack Deino, a senior money manager who helps oversee about $2.7 billion in emerging-market assets at Invesco Ltd. in New York. “There’s been just a lot of money out there looking for yield. Part of the selloff is attributable to the pulling back of QE, and you can’t do anything about that.”

Littered Floor

Prices on Markit Group Ltd.’s emerging markets index of credit-default swaps, which typically rise as investor confidence improves, have fallen to the lowest level since November 2011, according to data compiled by Bloomberg. That’s down from 114.3 on Jan. 3, the highest since April 2011.

The loss on emerging-market debt since reaching an all-time high on May 2 on JPMorgan Chase & Co.’s EMBI Global Total Return Index compares with a 2.3 percent decline on the Bank of America Merrill Lynch Global Broad Market Index.

A $500 million 4.875 percent Bolivian bond issued in October and due in 2022 has tumbled to 93.5 cents from as high as 102.5 cents on the dollar on May 6, according to prices compiled by Bloomberg.

“The floor is littered with knives,” Jeremy Brewin, who oversees more than $5 billion of fixed-income assets as the head of emerging-market debt at Aviva Investors, in London. “In a selloff, it’s a random experience. As much as I try to prove where things should be, I cannot.”

Hiding Places

Yields for borrowers in developing countries have climbed to 5.02 percent after reaching an unprecedented low of 4.04 percent on Jan. 24, according to the Bank of America Merrill Lynch U.S. Emerging Markets External Debt Sovereign and Corporate Plus Index. Relative yields on the debt reached 352 basis points, or 3.52 percentage points, the most since September.

“Safe assets are not entirely safe anymore,” Jeffrey Shen, head of emerging markets at BlackRock Inc., the world’s largest asset manager, said in an e-mail. “There’s not a whole lot of places to hide in the higher risk asset classes.”

Central bank policies holding down benchmark interest rates have enabled companies to borrow $1.9 trillion this year, 6 percent ahead of the pace in 2012, a record year with $3.97 trillion in sales, Bloomberg data show.

Tapering Signs

Investors are watching for signs of tapering after Fed Chairman Ben S. Bernanke said May 22 that the central bank could reduce $85 billion in monthly Treasury and mortgage debt purchases within “the next few meetings” if officials see signs of sustainable improvement in the labor market.

The Bank of Japan refrained yesterday from extending the length of loans it uses to smooth bond market volatility, according to a policy statement in Tokyo. Twenty of 23 analysts in a Bloomberg News survey forecast the BOJ would approve loans of two years or longer, or said that such a move was possible.

“It may be that we are seeing what happens when an overbought risk asset market adjusts to life without central bank largesse,” Gavan Nolan, director of credit research at Markit, wrote yesterday in a note to clients.

Spreads on emerging-market debt are normalizing after reaching “artificially low levels,” Nolan said in a telephone interview. Investors had failed to pay sufficient attention to each borrower’s risk when policies from the Fed and Bank of Japan drove money into developing-country funds, he said.

Funds Yanked

Investors pulled $1.5 billion from emerging-market bond funds in the week ended June 5, or 0.6 percent, paring this year’s inflows to 10.1 percent, according to EPFR data compiled by Bank of America Corp. strategist Jane Brauer.

“We’ve had a great run and now we have some doubt creeping into the picture,” said Scott MacDonald, head of research at MC Asset Management Holdings LLC in Stamford, Connecticut, which has about $600 million of assets.

Developing economies will grow 5.3 percent this year, the International Monetary Fund said April 16, after forecasting in January that growth would reach 5.5 percent. The forecast calls for growth of 1.2 percent for their advanced counterparts.

Rwanda’s expansion may slow to 7.5 percent this year from 7.7 percent in 2012, the IMF’s mission chief to the country Paulo Drummond said April 16. The country, rated B by both Standard & Poor’s and Fitch Ratings, five levels below investment grade, sold its debt April 16 at the lowest end of yield guidance given to investors, a person with knowledge of the deal said in April.

Turkey Protests

Anti-government protests in Turkey are threatening to drive away investors who had been lured by higher yields, falling debt levels and credit-rating upgrades. Credit swaps tied to Turkish debt, which pay the buyer face value if a borrower fails to meet its obligations, soared to 184 basis points yesterday from this year’s low of 110.9 on May 9, Bloomberg data show.

“That’s reminding people that political risk is still present,” Markit’s Nolan said. “When you’ve got this massive excess liquidity in the market, the likes of the political risk of Turkey can get overlooked.”

Elsewhere in credit markets, the cost of protecting corporate bonds from default in the U.S. rose. The Markit CDX North American Investment Grade Index, which investors use to hedge against losses or to speculate on creditworthiness, increased 0.6 basis point to a mid-price of 86.2 basis points as of 11:47 a.m. in New York, according to prices compiled by Bloomberg.

Rate Swaps

The index typically rises as investor confidence deteriorates and falls as it improves. 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, decreased 0.95 basis point to 16.75 basis points as of 11:48 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 Fairfield, Connecticut-based General Electric Co. are the most actively traded dollar-denominated corporate securities by dealers today, accounting for 5.3 percent of the volume of dealer trades of $1 million or more as of 11:48 a.m. in New York, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.

The Bloomberg Global Investment Grade Corporate Bond index has gained 0.25 percent this month, paring the decline for the year to 1.52 percent.

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