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Default risk fades in emerging markets as riskiest bonds soar

1 year ago
in Business, Economy, Features, highlights, Home, home-news, latest News, Markets
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Default risk fades in emerging markets as riskiest bonds soar

The risk of government defaults in emerging markets this year is subsiding, stoking a rally in bonds that were just recently teetering on collapse and propelling junk-rated sovereign debt to its best start to a year since 2019.

The prospect of a wave of investment in Egypt, a new government in Pakistan and a renewed political push for reform in Argentina have extended gains that many thought were petering out. Only 10 countries are now flashing signs of distress in the bond market, half as many as in 2022.

“We don’t see any major defaults in EM sovereign high yield this year,” said Anders Faergemann, a money manager at Pinebridge Investments. Market dynamics have completely changed in the past few weeks, he added, and the chance of a restructuring in Egypt, Argentina or Pakistan has “declined significantly.”

The rally in junk bond comes as some of the world’s most vulnerable economies push through free-market reforms and make progress in negotiations with the International Monetary Fund. That has renewed investor appetite for risk, especially as traders weigh the exact timing of interest-rate cuts by the Federal Reserve and other major central banks.

As junk bond prices surge, the extra yield investors demand to hold speculative-grade sovereign bonds over US Treasuries has declined 56 basis points this year, according to JPMorgan Chase & Co. data. That’s compared with an 11 basis-point increase for investment-grade bonds. The gap between the two has fallen to 513 basis points, the smallest in two years.

The most dramatic decline in risk premium is in sub-Saharan Africa, where the spread has narrowed to 644 basis points from over 1,000 in May 2023.

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Bouncing Back

Sovereigns that once scared away investors — including Argentina, Egypt, Ecuador and Sri Lanka — are leading global gains this year.

“The value lies in the single Bs and the triple Cs,” said Valentina Chen, co-head of emerging markets at investment firm Mackay Shields in London, who touts Argentina, Egypt and Kenya, as well as defaulted names like Zambia and Sri Lanka.

Hard-currency bonds in triple C rated countries have returned 16% this year, outperforming those in all other categories and nearly five times the average return of high-yield bonds issued by developing economies, according to data compiled on a Bloomberg index.

Egypt secured a deal with the IMF last week that doubled its rescue program to $8 billion after the country delivered its promise to devalue the currency and hike interest rates. Now the government expects billions more in investment from the World Bank, the European Union, Japan and the UK.

The nation’s sovereign bonds have returned 24% for investors this year, the second-best performer among peers, according to data compiled by Bloomberg.

The only nation outperforming Egypt is Ecuador, where President Daniel Noboa managed to “turn the country’s short-term security crisis early in January into a blessing in disguise” by consolidating powers, said Sergey Goncharov, a money manager at Vontobel Asset Management.

A potential agreement with the IMF also prompted Barclays economist Alejandro Arreaza and strategist Sebastian Vargas to move overweight on the credit and recommend buying the notes due in 2030.

The Chainsaw

Even perennial defaulter Argentina is gaining fans as it pursues talks with the IMF about a program that could unlock new cash and as President Javier Milei renews efforts to negotiate a radical overhaul of the economy.

“People are hopeful” of positive changes in Argentina, said Chen. “We see good policies in the pipeline.”

Countries in default are also making headway in restructuring talks, further bolstering high-yield sovereign bonds.

Sri Lanka expects to complete a debt revamp soon as the Asian country prioritizes obligations to private bondholders after it struck an agreement in-principle with official creditors last year. Zambia also vowed in January to resolve a standoff among its creditors.

All the same, investors are still watching money-market bets for Fed rate cuts closely, as well as commentary by monetary authorities in rich nations, for further clues on how far the high-yield rally can go.

To Oren Barack, managing director of fixed income at New York-based Alliance Global Partners, there is significant opportunity in both EM sovereign and quasi sovereign bonds as the Fed remains in the transitory pause period.

“There is some opportunity in Argentina, in the Bahamas and even beaten-down Venezuela and PDVSA,” Barack said, referring to bonds of Venezuela’s state oil company. “We will likely see further compression in EM, which should accelerate as the Fed gets closer to its first cut.”

It’s a view echoed by Shamaila Khan, head of emerging markets and Asia Pacific at UBS Asset Management in New York.

“The risk is significantly lower than what the market has priced,” she said. “A number of these countries are putting in place policy frameworks that show improvement and are getting funding from multilateral organizations.”

Source: bloomberg
Via: norvanreports
Tags: Default riskDefault risk fades in emerging markets as riskiest bonds soarriskiest bonds
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