By Paul Murray-John, executive director of Emerging Market debt at Threadneedle The performance ...
By Paul Murray-John, executive director of Emerging Market debt at Threadneedle
The performance of emerging debt during the summer has been volatile, particularly in Latin American credits. A combination of the difficult global environment and events in Brazil have been the main influences on credit spreads but there has also been a dramatic divergence of performance between regions and countries.
This has been a feature of the emerging bond market for some time and is partly a reflection of the disinflationary forces around the world, which punish profligate countries and benefit those that are fiscally conservative, with some notable exceptions within the G7.
Concerns about events in the Middle East and falling stock markets have had a deleterious effect on investor risk appetite and put pressure on emerging countries that need to borrow. However, there is a faint silver lining to the Iraqi cloud for countries that are oil exporters such as Russia and Venezuela.
The Asian borrowers have also performed well but, in their case, this is because the region continues to experience economic growth, which clearly improves their debt repayment capacity.
Nevertheless, the market's focus remains on Brazil, where there continues to be a withdrawal of money by banks, corporates, investors and savers as they protect themselves against the risk of Lula winning the presidency.
Recent opinion polls have shown an increasing likelihood of this occurring and it is rational for the market to price in this risk. The concern of the market is that although Lula, the Socialist candidate, has committed to responsible economic policies, he has a legacy of market unfriendly promises and there will be pressure on him to loosen fiscal and monetary policy. Consequently, the exchange rate has collapsed, domestic interest rates have jumped and country bond spreads have increased dramatically.
However, we may be approaching a market bottom in Brazil as we believe now the election campaign is a one-on-one contest between Serra (the government candidate) and Lula, we will see a massive campaign to undermine Lula's credibility.
The first round of the election took place on 6 October. If the election does reach a second round, we anticipate a small relief rally in Brazilian assets as it gives Serra even more time to build a potentially election winning strategy.
Latin American debt has fallen in sympathy with Brazil while Eastern European and Asian debt has been relatively resilient over the summer.
Despite the immediate concerns surrounding the outcome of the Iraqi situation, the longer-term global outlook of low interest rates, mild economic upturn and firming commodity prices continues to encourage investors to commit money to higher-yield sovereign debt for the longer term.
However, the outcome of the Brazilian election and the eventual macro-policy framework of the new government will need to become clear before the Latin American region returns to favour with investors.
Global activity turning up.
Commodity prices are rising.
Federal Reserve likely to keep rates low.
Outcome of Brazilian elections.
Investors' aversion to risk.
Situation in the Middle East.
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