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Dangers lie in wait for EM bull run
March 10, 2017 / 6:10 PM / 8 months ago

Dangers lie in wait for EM bull run

* EM bond supply continues

* Investors wary of valuations

* Rates sell-off hitting pricing

By Robert Hogg

LONDON, March 10 (IFR) - EM borrowers continue to push out mandates but there are signs of strain, especially at the margins.

Earlier this week Bollywood film producer and distributor Eros International is understood to have become the first Asian issuer to withdraw a dollar deal since Country Garden last November.

Another Asian high-yield issuer, China SCE Properties Holdings, saw its US$200m 5.875% five-year notes fall to a bid price of 99.2 from par, as investors become increasingly cautious ahead of a likely rate hike by the US Federal Reserve.

While the travails of a couple of esoteric high-yield issuers may not send tremors through the market, Brazil’s inability to price a tap of its April 2026s at the tight end of revised guidance is a bigger red flag.

The deal was expected to be for US$1bn-$1.5bn as Brazil squeezed pricing from low 5% to 4.95% (plus or minus 5bp). In the end, the sovereign launched a US$1bn offering at 5%.

“I don’t remember the last time a major sovereign got backed up [in pricing],” said one syndicate manger away from the deal.

Bankers in Europe are also becoming wary as deals towards the end of this week priced with bigger new issue premiums. Southern Gas Corridor priced a US$1bn tap of its March 2026s at 5.80%, 20bp back of where the outstandings were trading. Leads said the premium was 10bp once the move in Treasuries was taken into account.

Turkey’s Garanti Bank also found the going tough. “It was quite difficult,” admitted a banker close to the deal. The bank priced a US$500m six-year with a concession of at least 10bp.

Three weeks ago fellow Turkish lender, Yapi Kredi, printed with at most a marginal premium. Some bankers even argued the bonds came inside fair value.


The change in tone has been pretty swift. On Tuesday, the bid for EM assets was strong.

“Like a modern day Robocop, EM keeps wading through everything that’s being thrown at it and emerging the other side victorious,” said one trader in London.

“We have pending rate hikes, nearing the end of QE, President Trump’s economics, political risks in Europe and how to react to spreads at tights of the last two to three years. Yet every day (particularly in US time) we get waves of demand for risk assets.”

Yet the trader also recognised that things were not quite what they seemed. “The only thing that doesn’t connect is that for such a bullish environment, I don’t sense waves of optimism washing across trading floors.”

By Thursday, it was clear why. “In a way that only markets can, suddenly all the issues we have been discussing for a while do matter. [Ten-year Treasuries] at 2.57%, oil below US$50, EMFX weakness and spreads looking stretched all combining to bring a day of heavy selling across EMEA.”

By the end of the day, 10-year Treasury yields had jumped above 2.60% for the first time since December.


Even so, some investors remain constructive about the asset class, if only because of the technicals.

“I think a lot of investors saw valuations as relatively toppish already at the end of last month but as inflows keep coming into the asset class and the global environment remains relatively supportive, it is difficult to see where the trigger for a sell-off could come from in the near term,” said Delphine Arrighi, portfolio manager at Old Mutual Global Investors.

EM bond funds saw a sixth consecutive week of inflows with US$2.1bn of cash allocated. Hard currency funds received US$1bn.

All this while JP Morgan’s EMBI Global Diversified index tightened to a two-and-half-year low of 300bp by the middle of the week, 42bp in from the start of the year. That had helped the index deliver a total return of 3.36% as of March 8.

“The performance in EM this year has been outstanding,” said Uday Patnaik, head of emerging market debt at LGIM, though he added, “the second half of the year is going to be much more challenging.”

Patnaik identified a string of potential risks which could derail the EM train, including a marked strengthening of the US dollar, President Trump focusing on protectionism ahead of tax cuts, a downturn in commodities, a more hawkish Fed and a slowdown in China.

“It needs a lot of stuff to go right, and spreads are very tight at the moment,” said Patnaik.


The growth prospects for EM are also fragile due to high dependence on improved exports and higher commodity prices, according to Maarten-Jan Bakkum, senior strategist in emerging markets at NN Investment Partners.

“The main reasons are the weak fiscal positions in most countries...and the excessive credit growth over the past 10 years that has affected banks and debtors and now causes credit growth to be in a clear downtrend,” said Bakkum.

“Credit growth continues to outpace nominal GDP growth though (11% vs 8%), which probably means that the decline will continue for the time being. This makes the emerging world vulnerable in a scenario where global trade growth slows again.”

Still, markets are preparing themselves for more supply led by sovereigns. Kuwait, which is seeking to raise up to US$10bn next week, will be the headline grabber. But the move in rates means that pricing will be trickier even for a deal that is likely to get a huge order book. (Reporting by Robert Hogg (additional reporting by Daniel Stanton and Paul Kilby); editing by Sudip Roy and Julian Baker)

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