Emerging-Debt Rally Fuels Concern Amid Record Year for Sales

(Bloomberg) -- Investors are starting to worry that the world of emerging-market bonds is starting to overheat.

The Federal Reserve’s dovish turn and optimism about a trade deal between the U.S. and China spurred borrowers to raise about $360 billion in 2019, a record on a year-to-date basis. And more than $14 billion has flowed into developing-nation debt funds this year, EPFR Global data cited by Bank of America Merrill Lynch show.

Investors question how long the rally will last, and whether a potential shift by the U.S. central bank to an inflation-targeting policy will hurt returns. Bond buyers’ pursuit of extra yield is boosting demand for riskier notes of frontier markets such as Sri Lanka, whose debt slumped last year amid a leadership struggle, and Pakistan, where tensions with India are rising.

Emerging-Debt Rally Fuels Concern Amid Record Year for Sales

“Some of the frontier markets you would argue have probably tightened a little bit more than one would be comfortable with,” said Kenneth Akintewe, head of Asian sovereign debt at Aberdeen Standard in Singapore.

After a selloff last year, yields on emerging-market dollar bonds globally have fallen to near the lowest since May, according to a Bloomberg Barclays index. Here are some signs of how hot those notes are:

  • Qatar this week sold a three-part $12 billion bond after attracting about $50 billion in demand. It outdid its rival Saudi Arabia, which issued $7.5 billion of notes in January
  • Sri Lanka raised $2.4 billion through a dollar debt offering to investors on Friday, as it also seeks funding from the International Monetary Fund
  • Egypt raised $4 billion from the dollar debt market in February, signaling a return in investor interest
  • Malaysia sold a jumbo 200 billion yen ($1.8 billion) bond in first fundraising in the global debt market since its landmark election last year
  • U.S. currency bond orders for Asian borrowers soared to 6.7 times their issuance size in February, unprecedented since Bloomberg started compiling the data in 2016

Spreads on emerging-market bonds globally have tightened “a lot” and may need further catalysts to rally more, according to Leo Hu, senior portfolio manager for hard-currency emerging-market debt at NN Investment.

Emerging-market hard-currency debt could hand in a return of 8 percent this year but the market is likely to be “extremely volatile,” said Jean-Charles Sambor, London-based deputy head of emerging-market fixed income at BNP Paribas Asset Management.

Here are more investor views on developing-nation bonds:

Akintewe at Aberdeen Standard:

  • “Markets are just simply not as cheap”
  • Investment universe that’s more likely to lose money is local currency bonds, if their exchange rates correct
  • Concerned about levels of sovereign spreads, which have come in “fairly substantially”
  • Still sees opportunities in credit space

Sambor at BNP Paribas Asset Management:

  • “In hard currency, we see opportunities in the high-yield space in a couple of countries like Ukraine”
  • “The Fed might move from dovish to neutral but it’s unlikely to move from dovish to hawkish”

Hu at NN Investment:

  • “Investors still have cash, and there is a wall of money still trying to find a home”
  • “The Fed has been dovish and U.S.-China talks have made progress, improving risk sentiment”

Todd Schubert, head of fixed-income research at Bank of Singapore:

  • There is potential for more gains, particularly in Asia high yield, which currently still trades over 140 basis points more than the tightest level in 2018. The interest rate outlook is actually quite benign and supportive of credit markets over the remaining year
  • However, after the run-up in the first two months of the year, “the market will need to see demonstrable progress on the U.S.-China trade talks before we take another leg higher”
  • Absent this, markets may just remain range-bound for the near-term and in more of a “coupon-clipping” mode

©2019 Bloomberg L.P.