Emerging bond issuance and inflows have had a strong start to the year but can it last?
Data from JPMorgan shows that emerging market sovereigns sold hard currency bonds worth $9.6 billion last month while companies raised $51.2 billion (that compares with Jan 2012 issuance levels of $17.5 billion for sovereigns and $23.9 billion for corporates). Similarly, inflows into EM debt were well over $10 billion last month, very probably topping the previous monthly record, according to JPM.
But U.S. Treasury yields are rising, typically an evil omen for equities and emerging markets. Ten- year U.S. yields, the underlying risk-free rate off which many other assets are priced, rose this week to nine-month highs above 2 percent. That has brought losses on emerging hard currency debt on the EMBI Global index to 2 percent so far this year. (there is a similar picture across equities, where year-to-date returns are barely 1 percent despite inflows of around $24 billion). Historically, negative monthly returns caused by rising U.S. yields have tended to lead to outflows.
The S&P500 U.S. equity index is trading at five-year highs, however, despite Treasuries’ creep higher. That would appear to indicate greater confidence in the growth outlook. Support for emerging markets may also come from Japanese retail cash that is fleeing a falling yen. Morgan Stanley analysts, for instance, do not expect significant outflows just yet, noting that “the nature of inflows overall (into emerging debt) has been more structural than in past years and therefore tends to be much stickier”. They add:
We believe that EM investors should not be overly concerned. The main reason for this is the expectation of a range-bound UST going forward, with only 25 bps further widening projected. Neither the pace nor the extent of this change seems disruptive to us, even with a potential temporary overshoot on the upside.