Pimco, Goldman Asset See China as Threat to Emerging BondsBy and
Over $1.5 trillion of emerging securities to mature in 2018
While not base case, China deleveraging risk worth watching
Some of the world’s biggest investors are warning that the hottest market for emerging debt since the global financial crisis could cool in 2018.
Central banks are set to raise rates, making it more expensive for firms to roll over massive borrowings. Geopolitical issues are smoldering. And then there’s China’s deleveraging. If that chills economic growth, developing bonds elsewhere may falter, according to investors including Pacific Investment Management Co. and Goldman Sachs Asset Management. Their base case is that there’s still value, but the risks are increasingly key to watch.
The developing market growth story still has legs, but any unexpected trouble in China would be a setback, according to Owi Ruivivar, a managing director in emerging market debt at Goldman Sachs Asset Management. “It’s hard to see China going through a tough situation and growth in global and emerging markets doing well,” she said.
President Xi Jinping has so far seemed to thread the needle -- curtailing excessive borrowing in the financial system without derailing economic growth -- and data on Thursday showed the economy had its first full-year acceleration since 2010. Still, there are strains. A local bond market rout has pushed borrowing costs higher and several asset management products missed payments in recent days amid a crackdown on shadow banking.
“Policy makers in Beijing are seemingly stepping up their deleveraging efforts onto the economy,” said Michael Gomez, head of emerging-markets portfolio management at Pimco.
The various threats come at a turning point for money markets globally. Central banks from Tokyo to Frankfurt have kept policy rates near zero for years, prompting yield-starved fund managers to pile into riskier assets. That’s driven yield premiums on dollar notes from emerging markets to the lowest since 2007.
At the same time, expectations for monetary authorities to start reining in stimulus have prompted investors to lower their expectations. Returns on such corporate securities slipped to 8 percent in 2017 from 11 percent the previous year, according to a Bloomberg Barclays index.
BlackRock Inc., the world’s largest asset manager, expects returns for emerging-market dollar bonds to moderate to 4 to 6 percent this year, but doesn’t see a reason to be bearish. Such securities normally suffer when the dollar strengthens or when the credit cycle turns, but neither appear to be happening, according to Neeraj Seth, Singapore-based head of Asian credit.
Still, there are other threats, including debt bills in emerging markets. More than $1.5 trillion of such bonds and syndicated loans mature through the end of this year, the Institute of International Finance has estimated.
The Federal Reserve, European Central Bank and other major central banks are moving toward the first simultaneous tightening in more than a decade, which could hurt the ability of debt-laden borrowers to service those obligations.
Those central bank steps, along with China’s heightened efforts to deleverage, pose risks to developing nation bonds, according to Karan Talwar, Hong Kong-based investment specialist for emerging-market debt at BNP Paribas Asset Management. Any unexpected pickup in global inflation is another risk, according to Benjamin Robins, a portfolio specialist for emerging markets debt at T. Rowe Price Group Inc.
For many investors, one strategy is to focus more on local-currency securities -- particularly after warnings from investors including Man Group Plc that current valuations on dollar bonds from developing countries “no longer make sense.”
Pimco is using the buoyancy in the market to reduce exposure on certain dollar debt in developing markets, and finds holding local notes unhedged more attractive than external bonds, according to Gomez. Goldman Sachs Asset sees “a lot more scope” for out-performance in local currency bonds, Ruivivar said.