The awful terrorist attacks of 11 September have had considerable impact on the outlook for emerging...
The awful terrorist attacks of 11 September have had considerable impact on the outlook for emerging market debt.
The asset class has always been particularly sensitive to external influences and these have deteriorated. A global economic turnaround has been delayed by at least three quarters, the oil price has collapsed, and a jump in risk aversion has cut off external financing for most borrowers. However, there is a silver lining for our asset class, which is the new strategic importance of several emerging countries to the US and policymakers' commitment to forestalling a global recession via looser monetary and fiscal policy.
With hindsight, the risk aversion trade has had probably the largest impact on our market, as countries where investors and the market were most heavily invested have suffered more relative to countries that were under-owned.
The relative outperformance by Argentina compared to the large fall in Russian debt is a good example of this particular technical dynamic. A related dynamic has been selling of relatively good credits by crossover investors who held them as off-index positions and consequently had little appetite for a jump in volatility. Mexico probably suffered disproportionately to its deteriorating fundamentals on the back of this kind of selling.
Although risk aversion accounted for much of the relative country performance shortly after the attacks, there has been a consistent underperformance by Brazil, which is probably driven primarily by more fundamental concerns. The country has a rapacious demand for dollars to fund its current account deficit, which it does in more normal times by attracting FDI and borrowing externally, but in the new global environment this is likely to be a real challenge. Combined with the unfriendly external environment is the approaching presidential election, which muddies the political outlook.
Although the country is blessed with a market savvy Central Bank, its credibility is compromised by market cynicism about the prospects for further fiscal adjustment (tightening). Investors are aware that the IMF is waiting in the wings to provide help in the event of a dramatic deterioration (maybe induced by Argentina), but are unwilling to anticipate this, and the debt market continues to underperform.
In addition to the shockwaves from the attack, the other market moving news recently has been the dreadful August tax collection results in Argentina. There is nothing positive to say about these numbers, which reflect a continuing collapse in domestic activity and put immense pressure on the politicians, as they now have to find in the region of another $900m of spending cuts in order to satisfy the zero deficit financing law.
The light at the end of the tunnel provided by stable to improving deposit flow has been extinguished and the outlook has deteriorated commensurately.
The outlook for emerging markets is more difficult now because of the challenges in Argentina and Brazil. However, from a spread or value perspective the asset class as a whole is starting to look very attractive on a medium-term view. Looking back over the 90s, investing at this level of spread (10% over US Treasuries) has always provided positive returns over a 12-month holding period.
Historically wide spreads.
United States monetary easing.
Selective support from IMF.
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