Wall Street’s biggest firms are predicting intensifying bond losses in emerging markets, where borrowing costs already have soared to the highest in more than four years vs. U.S. 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., 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 markets bond funds since the end of April, almost five times the amount pulled from U.S. corporate credit, according to EPFR Global. That’s pushed the extra yield that buyers now demand to own dollar-denominated emerging markets debt instead of U.S. 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 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 May 22 that the central bank could scale back the pace of its $85 billion of purchases of mortgage bonds and Treasuries if the U.S. economy showed sustained improvement.
Emerging markets debt has lost 7.9% since the end of April, vs. a 5.1% decline on U.S. 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 J.P. Morgan Chase & Co. wrote in a Sept. 5 report.
In emerging markets, relative yields narrowed 8.9 basis points last week to 366.2 basis points, according to J.P. Morgan’s EMBI Global index. The measure has averaged 307.4 this year.
Following average annual returns of 15.3% in the four years ended Dec. 31, 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 U.S. Corporate & High Yield index.
“Developed markets paper has held in much better than emerging markets paper,” said Stephen Antczak, the head of U.S. credit strategy at New York-based Citigroup Inc., the second-biggest underwriter of emerging markets 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 markets debt was seen as a haven with higher-yielding securities amid a U.S. stimulus program that’s funneled more than $2.6 trillion into the financial system since September 2008.
Yields on the Bank of America Merrill Lynch U.S. 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 U.S. company debt widened to as much as 1.44 percentage points on Aug. 31, 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 U.S. corporate bond funds, EPFR data show.
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.
Asian economies have been among the hardest hit. A J.P. Morgan index of Indian dollar-denominated bond yields touched 6.525% on Sept. 5, 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%.
“Emerging markets risk has gone up more than the risk associated with U.S. corporates,” Mr. Rosenberg said. “We’re not yet ready to say it’s time to pile into emerging markets.”
