Emerging market dollar debt carries no immunity to global risk aversion gripping markets in late 2018. While Argentina’s near sovereign collapse received a significant amount of media attention, the weakness was broad-based, with nearly all major constituents in the red. All told, last year’s 4.3% loss represented Emerging market dollar debts first decline since 2013 (when measured annually). Even prior to October, sell-offs in EMs since the currencies turbulence began in April has weighed on the overall level of debt-raising.
Investors might be familiar with the current environment; in 2018 emerging markets have sold the smallest amount of dollar-denominated debt in six years, as the sharp strengthening in the dollar and associated sell-off in EM currencies rippled the debt sector. Instead issuances of debt were undertaken in other currencies, with $277bn of non-dollar-denominated debt sold in the same six-month period. Kazakhstan, for example, sold €1.05bn of bonds in euros for the first time.
Last year’s weakness has improved the allure of emerging market dollar debt. Considering emerging market dollar spreads of 403 basis points stand above their post-crisis average, while yields of 6.85% have been lower 88% of the time over the same period. In addition, it has never experienced two consecutive years of losses, which augers well for 2019’s prospects. Emerging market sovereign bonds remain vulnerable to higher US interest rates. With the federal reserve seemingly pausing further interest rate hikes, some additional safety is to be considered. Moreover, the number of dedicated emerging market dollar debt investors with overweight positions now stands near its post-crisis highs, creating vulnerability to weakness.