Debt investors bet on emerging markets as ‘QE’ begins to travel

Emerging market debt investors are betting the rally that has lifted sovereign bonds from their March lows will gain pace, as stimulus efforts from the Federal Reserve and others spill across borders and as local policymakers launch copycat measures.

More than a dozen central banks across emerging markets have bought local-currency government bonds or other assets as part of special programmes to fight the effects of Covid-19, including Indonesia, Poland and the Philippines. Countries on shakier financial footings, such as South Africa and Turkey, have also done so.

Alejo Czerwonko, a strategist at UBS Global Wealth Management, noted that such purchases differed slightly from the “quantitative easing” programmes employed after the global financial crisis. This was because in many of the participating countries, interest rates were not yet at zero and the relatively small operations lacked fixed targets for purchases. But he said the policy, if used prudently, could help to buttress the countries’ recoveries by “safeguard[ing] the functioning of domestic bond markets”.

QE-like efforts around the world have “supported the market and . . . reduced financing costs,” said Paul Greer, an emerging market portfolio manager at Fidelity International.

Sovereign bonds in the benchmark JPMorgan EMBI Global Diversified index have risen nearly 20 per cent in value since March 23, while the extra yield demanded by investors to hold the debt versus US Treasuries has narrowed by more than 30 per cent from the worst of the sell-off. Emerging and developing economies have also been able to access international capital markets in droves since April, raising more than $83bn, according to data compiled by the Institute of International Finance.

Line chart of JPMorgan EMBI Global Diversified index showing Emerging market sovereign bonds rebound from March lows

According to Mr Greer, the turning point in late March came after the Fed unleashed “mega QE and essentially put a floor under risk assets,” pledging to buy corporate bonds and an unlimited quantity of government debt, among other measures

Before this show of support, which came alongside extra spending packages by governments around the world, the Fed had slashed rates to zero, opened swap lines with 14 central banks to lower the cost of dollars internationally and set up programmes to ensure companies and households could access credit. The US central bank has since introduced more emergency facilities and promised to do more if necessary.

“These global liquidity operations don’t stay within borders — they spill over into the developing world,” said Eric Baurmeister, head of emerging markets fixed income at Morgan Stanley Investment Management.

The March sell-off, coupled with radical action from global policymakers, created what Uday Patnaik, head of emerging market debt at LGIM, says was one of the best opportunities to increase EM exposure he had seen in his 30 years of experience.

“If you want to do it, it’s now,” he said he told clients who had expressed interest in emerging markets before the global pandemic. Mr Patnaik said the firm significantly increased its investments in dollar-denominated sovereign bonds issued by India, the Philippines and Panama roughly three months ago, and continued to see ample room for additional gains from Egypt and Qatar. Kevin Daly, a portfolio manager at Aberdeen Asset Management, for his part, flagged Nigeria, Ghana and Kenya as offering value.

Many investors appear to be sanguine about the effects of the virus. Capital Economics recently noted that the number of new confirmed infections in India, Saudi Arabia, Egypt, Latin America and Sub-Saharan Africa was nearly equivalent to that for the rest of the world combined. Yet, many of these regions are moving forward with plans to gradually reopen. More Covid-19 cases will ensue, but investors say it may be less economically damaging than keeping stringent lockdowns in place. 

“Ultimately, every EM country has realised a pause in reopening is prohibitive,” said Polina Kurdyavko, head of emerging markets at BlueBay Asset Management.

Beyond the risk of a worsening pandemic, Fidelity’s Mr Greer says the current crisis, and the government spending undertaken to combat it, would create a new set of vulnerabilities down the road. 

JPMorgan already sees a default rate of 16 per cent over the next 18 months, based on its study of 41 risky emerging market countries, as debt-to-GDP levels for more than one-third of the countries analysed reaches an estimated 80 per cent or higher. By the end of 2021, the bank expects the default rate for these countries to rise to 34 per cent.

“The whole idea of heavy debt burdens is not going to go away today or tomorrow,” said Mr Greer. “It is here to stay.”

Still, he said the near-term outlook for emerging markets was “positive”, buoyed in part by central banks globally now snapping up assets. 

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