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Borrowing costs are soaring from record lows reached in January as speculation deepens that the Fed will curtail its so-called quantitative easing as soon as this month. Photo: Mint (Mint)
Borrowing costs are soaring from record lows reached in January as speculation deepens that the Fed will curtail its so-called quantitative easing as soon as this month. Photo: Mint

BlackRock predicts deeper emerging-markets rout

Investors have pulled $22.1 bn from emerging-market bond funds since the end of April

New York: Wall Street’s biggest firms are predicting intensifying bond losses in emerging markets, where borrowing costs have already soared to the highest in more than four years versus US corporate debt, as the Federal Reserve considers curtailing record stimulus.

“We’re not yet convinced that we’ve seen the worst in terms of flows out of emerging markets," Jeffrey Rosenberg, the chief investment strategist in fixed-income at New York-based BlackRock Inc., the world’s largest asset manager, said in a telephone interview, expressing his own views. “We see a lot of valuation change but we see the potential for even more valuation change."

Investors have yanked $22.1 billion from emerging-market bond funds since the end of April, almost five times the amount pulled from US corporate credit, according to EPFR Global. That’s pushed the extra yield that buyers now demand to own dollar-denominated emerging-market debt instead of US company notes to 1.4 percentage points, about the most since December 2008.

Borrowing costs are soaring from record lows reached in January as speculation deepens that the Fed will curtail its so- called quantitative easing as soon as this month, signaling an end to the flood of cheap money that propped up asset prices from India to China and Indonesia. The exodus from developing nations began after Fed chairman Ben S. Bernanke told Congress on 22 May that the central bank could scale back the pace of its $85 billion of purchases of mortgage bonds and Treasuries if the US economy showed sustained improvement.

‘Defensive View’

Emerging-market debt has lost 7.9% since the end of April, versus a 5.1% decline on US corporates, Bank of America Merrill Lynch index data show. While an expansion in the world’s biggest economy is accelerating, growth in China is projected to slow to 7.5% this year from as high as 14.2% in 2007, according to 53 economists surveyed by Bloomberg.

Given the likelihood of further rate volatility and an uncertain emerging-markets growth outlook, we maintain our defensive view on corporates from developing countries, analysts led by Eric Beinstein in New York at JPMorgan Chase & Co., the world’s largest underwriter of corporate bonds, wrote in a 5 September report.

Elsewhere in credit markets, the extra yield investors demand to hold corporate bonds worldwide instead of government securities rose for a third week. Sprint Corp. led bond sales to the highest level since May with the biggest high-yield offering in more than five years. Loan prices increased.

Default swaps

Relative yields on investment-grade bonds from the US to Europe and Asia widened 1 basis point to 149 basis points, or 1.49 percentage points, according to the Bank of America Merrill Lynch Global Corporate Index. Yields rose to 3.225% from 3.088% on 30 August.

The cost of protecting corporate bonds from default in the US declined. The Markit CDX North American Investment Grade Index, a credit-default swaps benchmark that investors use to hedge against losses or to speculate on creditworthiness, decreased 2.2 basis points last week to a mid-price of 81.8 basis points, according to prices compiled by Bloomberg.

The Markit iTraxx Europe Index of 125 companies with investment-grade ratings dropped 1.6 to 102.7 to the lowest level since 26 August at 10:28 am in London. In the Asia-Pacific region, the Markit iTraxx Asia Index of 40 investment-grade borrowers outside Japan fell 5.7 to 140.

Verizon bonds

The indexes typically fall as investor confidence improves and rise as it deteriorates. Credit swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a swap protecting $10 million of debt.

The Bloomberg Global Investment Grade Corporate Bond Index has declined 0.63% this month, bringing losses for the year to 3.95%.

Bonds of Verizon Communications Inc. were the most actively traded dollar-denominated corporate securities by dealers last week, accounting for 3.9% of the volume of dealer trades of $1 million or more, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.

The New York-based company will meet investors in the US and Europe this week as it prepares to sell as much as $50 billion of debt to buy Vodafone Group Plc out of their wireless joint venture, according to a person with knowledge of the matter. “A first offering may exceed Apple Inc.’s record $17 billion issue in April," another person said last week.

Sprint sale

Sprint, the third-largest US wireless carrier, led $80.4 billion of corporate bond sales worldwide, the busiest week since $123.9 billion was issued in the five days ended 17 May and up from $42.3 billion in the prior period, according to data compiled by Bloomberg.

The Overland Park, Kansas-based company, acquired in July by Japan’s SoftBank Corp., sold $6.5 billion of eight- and 10- year notes on 4 September in the biggest junk offering since Intelsat priced $7.1 billion of bonds through three units in June 2008, Bloomberg data show.

The Standard & Poor’s/LSTA US Leveraged Loan 100 index rose 0.04 cent to 97.68 cents on the dollar, the highest since 22 August. The measure, which tracks the 100 largest dollar- denominated first-lien leveraged loans, has returned 3.11% this year.

In emerging markets, relative yields narrowed 8.9 basis points last week to 366.2 basis points, according to JPMorgan’s EMBI Global index. The measure has averaged 307.4 this year.

‘Disproportionate selloff’

Following average annual returns of 15.3% in the four years ended last December, dollar-denominated emerging markets notes have lost 6.8% this year, according to Bank of America Merrill Lynch index data. That compares with a 2.9% loss in 2013 on the Bank of America Merrill Lynch US Corporate & High Yield index.

“Developed markets paper has held in much better than emerging markets paper," said Stephen Antczak, the head of US credit strategy at New York-based Citigroup Inc., the second- biggest underwriter of emerging-market bonds. “What worries me is if you don’t have this natural support in place, you could get a disproportionate selloff in emerging markets."

Investors are withdrawing more cash from developing nations’ bonds after pouring $58.8 billion last year into funds that buy the debt, EPFR data show. Emerging-market debt was seen as a haven with higher-yielding securities amid a US stimulus program that’s funneled more than $2.6 trillion into the financial system since September 2008.

Avoiding India

Yields on the Bank of America Merrill Lynch US Emerging Markets External Debt Sovereign and Corporate Plus index have climbed to 5.73% after reaching an all-time low of 4.04% on Jan. 24.

The gap in yields with US company debt widened to as much as 1.44 percentage points on 31 August, the most since reaching 1.47 percentage points on Dec. 1, 2008.

The $22.1 billion of outflows from emerging-market debt funds in the past four months compare with $4.6 billion of withdrawals from US corporate bond funds, EPFR data show.

Asian economies have been among the hardest hit. A JPMorgan index of Indian dollar-denominated bond yields touched 6.525% on 5 September, the highest since January, with BNP Paribas SA forecasting economic growth of 3.7% through next March, compared with a 10-year average of about 8%.

“India is one country we’re completely avoiding and have been doing so for 12 months," said Hayden Briscoe, a Hong Kong- based director of Asia-Pacific fixed-income at AllianceBernstein Hong Kong Ltd.

Fed meeting

The US, which plunged into a recession five years ago as spiraling home values prompted a credit seizure, will probably grow by 2.7% next year and 3% in 2015 from 1.6% this year, a Bloomberg survey of 73 economists shows.

With the Fed expected to start decreasing its bond-buying program at its 17-18 September meeting, borrowing costs have climbed for bonds globally. Yields on 10-year Treasuries reached 2.99% on 5 September, the highest since July 2011.

The underperformance of emerging-market debt relative to US corporate notes has been sustained for one of the longest periods in history, the JPMorgan analysts wrote in their report.

“When underperformance causes a selloff in the market and liquidity worsens as a result, you have a huge gapping in risk valuation," said Edwin Chan, the head of credit research at UBS AG in Hong Kong.

While the rout may eventually present a buying opportunity—Mark McCombe, BlackRock’s Asia-Pacific chairman, talking to Bloomberg TV on Monday, said China’s economy is stablizing and he’s pretty positive on it—losses for emerging markets debt have the potential to accelerate, BlackRock’s Rosenberg said.

“Emerging markets risk has gone up more than the risk associated with US corporates," Rosenberg said. “We’re not yet ready to say it’s time to pile into emerging markets." Bloomberg

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