The giant crush of yields
Investors are in a massive search for carry as an increasing percentage of the bond markets is generating negative yields. This, amongst other factors, has fuelled huge inflows into emerging market debt (EMD). We are long hard currency EMD and the position has benefited from this search for yield. We wonder, however, has EMD now become too expensive?
We ask ourselves three questions:
Q. Are EMD spreads tighter than the average of the last decade?
A. No. With the EMBI global diversified sovereign spread at 364bps, it is still at the top end of the interquartile range as shown in the chart below. This is not just about the mix of debt having changed: it is true for the high yield part of the index and is also true of the investment grade part of the index.
Q. Are EMD spreads tighter relative to equivalently-rated corporate debt?
A. No. They’re clearly not as cheap as in 2013/14, but EMBI spreads are still nearly 40bps above equivalently-rated corporates (see below).
Q. Are emerging market sovereign credits more likely to default than equivalently-rated corporate debt?
A. No … or at least, not historically. Over the last twenty years, 10% of high yield corporate issuers have defaulted over a five-year period. This compares to 5% for high yield sovereigns. There is nothing to suggest that ratings agencies are systematically more generous to sovereigns than corporates.
In light of this we are sticking with our long EMD position.