Emerging Mkt Debt Spreads Lag Rise In US Tsys-Creditsights
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NEW YORK (Dow Jones)--Emerging market debt spreads have so far lagged the rise in U.S. Treasurys yields, but will likely begin to widen later this year as investors perceive the impact of less global liquidity, according to research firm CreditSights.
"Most people would agree that strong global liquidity support has helped drive emerging market spreads to record lows," CreditSights analyst Christian Stracke said during a conference call.
Since 2003, "there has been a very strong negative relationship between Treasurys yields and emerging market sovereign spreads," Stracke said. But, "the relationship acts with a fairly strong lag."
With monetary policy tightening in most major economies, including the U.S., the European Union and Japan, global liquidity will start to dry up and a more normal positive relationship should be restored, and "emerging market spreads will have to move somewhat higher," Stracke said.
Spreads on JPMorgan's Emerging Markets Bond Index Plus are currently at 184 basis points over U.S. Treasurys, just shy of the record 183 basis points reached on Apr. 20. That comes despite a consistent rise in U.S. Treasurys yields, with the benchmark 10-year note reaching a high of 5.08% on Tuesday.
In 2002, central banks worldwide were pumping liquidity but emerging markets "didn't get much traction" immediately, as it took a while for investors to realize that yields on high-quality debt were low and they would have to reach down the credit curve in search of higher yields, Stracke said.
"The same kind of lag will occur over the next several months in the relationship between Treasurys yields and credit spreads, especially emerging market spreads," Stracke said.
As this happens, it should restore the normal trend between rising U.S. Treasurys yields and widening emerging market credit spreads, he said.
"It has only been a while that (Treasurys) yields have been anywhere close to 5%. It will take some time but eventually the growth in liquidity will slow down considerably, especially if yields go higher than 5%," Stracke said.
For the time being, an equilibrium has been reached between the rise in global liquidity and new issuance from emerging markets, Stracke said. Throughout the rest of 2006, net issuance is likely to remain strong out of emerging markets, including both sovereign and corporates, while global liquidity is likely to slow, he said.
The gap between new issuance and global liquidity "will rise further in the second half of this year, which should lead to less supportive global macro conditions going forward," he said. This would help pressure emerging market spreads to widen further.
Stracke agreed with the broad consensus that there have been fundamental improvements in emerging market economies over the last eight to 10 years. But he warned that, in 15 out of 20 countries examined by CreditSights, macroeconomic indicators are expected to deteriorate in 2007 compared with 2006, continuing a trend seen this year versus 2005.
"Fiscal balances and current account balances are going in the wrong direction," Stracke said.
Nevertheless, although there may be "less supportive technicals, it doesn't necessarily mean a crisis is on the way," Stracke noted.
While global liquidity has driven emerging market spreads lower, "it probably has not led investors to be over-invested in emerging markets" in a way that they may have been back in 1997 and 1998, he said.
The "hot money" phenomenon has improved in many countries, which are now less vulnerable to sudden, sharp retractions by overseas investors, Stracke said. Nevertheless, he said Turkey and Hungary are "vulnerable" should there be a significant external shock to emerging markets.
Furthermore, banking systems are better positioned than in the past, and it seems there are "very few countries where it appears domestic banking systems have been on a lending binge," Stracke said. While banking systems may be affected by an economic crisis, they are unlikely to be the trigger, as they have been in the past, he said.
-By Matthew Cowley, Dow Jones Newswires; 201 938 5692; matthew.cowley@dowjones.com
(END) Dow Jones Newswires
April 25, 2006 13:10 ET (17:10 GMT)
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