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Trade War More Damp Squib Than Big Bang, EM Bond Traders Say

Updated on
  • Investors stick with metals firms citing improving financials
  • Yield premium on corporate bonds falls after tariff talk

SocGen's Lawson Likes Indonesia, India in Emerging Markets

For bond investors in emerging markets, Donald Trump’s trade war is a non-event.

The average yield of corporate bonds in developing nations has fallen seven basis points to its lowest in a month since the U.S. president threatened to raise import tariffs on aluminum and steel. Investors have also lowered the extra return they demand over Treasury yields to own the bonds.

Not that emerging markets can remain immune to a rapid increase in the cost of exports or a dwindling of world trade. After all, Russia, Mexico, Brazil, South Korea and United Arab Emirates are major sellers of the products the U.S. has targeted. But analysts from Pictet Asset Management to AllianceBernstein say the scale of the impact will be nowhere near what’s feared.

“There will be some sectors and some companies which will be affected in the mining area but in general, I would not change my positive opinion,” says Alexander Odermann, a portfolio manager at Deka Investment in Frankfurt. “Emerging-market corporates are still very solid. I am more overweighted in emerging markets than any other assets at the moment.”

Even Fitch Ratings isn’t perturbed by the Trump onslaught on emerging-market exports. The London-based credit-rating company says default rates in 2018 will stay low, with or without higher U.S. tariffs.

Key reasons for the bond investors’ optimism on developing-nation companies:

Falling Leverage

The ratio of the firms’ debt-to-cash flows has been falling since 2015 as operational profitability improves, with net debt growth lagging behind. Last year’s jump in earnings before interest, taxes, depreciation and amortization was the best since 2011, according to a research note from JPMorgan Chase & Co..

“I don’t really see a leverage problem in the EM corporate space,” says Odermann.

Default Rates

The number of emerging-market corporates rated B- and with negative outlooks, and those with even lower grades, has fallen to 22 from 29 a year ago, according to Fitch. The default rates for these speculative-grade companies may remain modest even with higher tariffs.

“Our expectation is another year of fairly low default rates thanks to the economic backdrop,” says Alex Griffiths, group credit officer at Fitch Ratings. “Both emerging and developed markets are growing. So, we’re seeing an improving environment in a lot of different places.”

China Cuts

Cash generation in the steel and aluminum industries is generally healthy, according to AllianceBernstein. 

“Steel producers in Brazil, Russia and Korea have a low cost base, focus on their own local markets and benefit from sound credit metrics,” says Okan Akin, a London-based credit analyst. “Ongoing capacity cuts in Chinese steel manufacturing provides the main boost for the steel industry globally.”

Refinancing

An expanding local-investor base is making it easy for companies to raise funds and this is easing the stress on refinancing, according to Pictet Asset Management. 

“Refinancing risk in global emerging corporates is essentially an Asia centric question, as the bulk of bond maturities in the coming years are concentrated in that region,” says Alain Defise, head of emerging credit at Pictet. “However, we feel comfortable about that situation because Asia is also the region where you have the strongest domestic buyers’ base.”

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