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Yield hunting is back in emerging markets with a force not seen for 17 years.
Investors are buying the bonds of some of the world’s poorest nations so fast that the risk premium on them is falling at the quickest pace since June 2005 relative to their investment-grade peers, JPMorgan Chase & Co data show. And countries that were tottering on the brink of default just months ago — such as Pakistan, Ghana and Ukraine — are leading this high-yield rally.
Before this month, the most brutal selloff since the 2008 financial crisis already had emerging-market money managers talking about how cheap high-yield bonds were and how their underperformance against higher-rated debt was an unsustainable distortion. But the bonds continued to be shunned because of a surge in US yields driven by the Federal Reserve’s aggressive monetary tightening. It’s only now, with the prospect for a slower pace of interest-rate hikes, that investors are returning.
“Cheaper high-yield emerging-market bonds do look more attractive relative to investment grade,” said Ben Luk, a senior multi-asset strategist at State Street Global Markets. The recent rebound in commodity prices, especially oil, could also “generate greater cash flow and lower the chance of any sovereign default in the near term.”
The extra yield investors demand to own high-yield sovereign bonds in emerging markets rather than Treasuries narrowed 108 basis points in the month through the 15th, a JPMorgan index showed. The spread on similar gauge for higher-rated debt narrowed only 23 basis points. That led to the gap between them shrinking by 85 basis points, the biggest monthly drop since the Fed raised rates eight times by a total of 200 basis points in 2005.
The high-yield outperformance comes as a wave of defaults predicted in the wake of Russia’s invasion of Ukraine has yet to materialise, with the exception of Sri Lanka. Most other nations have continued to service their debts, with some clinching deals with the International Monetary Fund.
That’s made investors confident enough to return to the bonds for their double-digit returns. -Bloomberg
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