While EM economies have unique exposure to both COVID-19 and the oil price crash, we still see value in the higher quality part of the market.
In recent weeks, emerging markets have had to cope with the dual shocks of coronavirus/COVID-19 containment measures and the breakdown of OPEC+ negotiations. We’ve already seen EM central banks move to reduce benchmark interest rates and boost liquidity, and most EM countries are planning large relief programs to ease the shock on their local economies. As EM countries typically do not have the balance sheet capacity to boost spending on their own, we expect EM sovereigns to aggressively lock in funding for these relief programs via external, local and multilateral sources. As a result, we believe that a key theme for EM in 2020 will be a material increase in external (USD-denominated) sovereign bond issuance.
At the beginning of 2020, we expected gross EM hard currency sovereign issuance to be approximately $150 billion, much of which would go to refinance existing borrowings. As the magnitude of the growth shock from coronavirus and energy has unfolded, we now believe this year’s new supply will be as much as $300 billion. This could make issuance nearly twice the annual amount of recent years (Exhibit 1), which will be both an important technical in our market as well as an opportunity for Western Asset clients.
Handicapping Coronavirus Spending
We are already seeing a wide variety of planned fiscal relief programs in EM countries to combat fallout from the virus. The size of virus relief packages will obviously vary depending on countries’ willingness and ability to fund new spending. For example, Peruvian authorities are planning relief measures that will cost nearly 12% of GDP. Admittedly, Peru has plenty of fiscal space within the A3/BBB+ credit bucket to embark on this one-time fiscal expenditure. On the other hand, Israel has taken a more conservative approach and plans to spend about $22 billion (5% of GDP) to combat the viral outbreak, about a quarter of which was raised in March via new USD-denominated bonds.
For the purpose of this exercise, we assume that EM countries implement additional outlays amounting to 5% of GDP. Clearly not all of the additional EM fiscal spending will be financed through the USD-denominated sovereign market, as we would expect domestic and multilateral sources to complement bond issuance. But assuming that one-fifth of total needs are financed externally, this would amount to additional external sovereign issuance of $150 billion.
Exhibit 1: EM Sovereign USD-Denominated Issuance
Source: JPMorgan, Western Asset. As of 08 Apr 20. Past performance is no guarantee of future results. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.
Fiscal Slippage From the OPEC+ Fallout
Further exacerbating coronavirus-impacted fiscal dynamics is the oil shock. For oil-dependent nations in particular, revenues will likely undershoot beginning-of-year estimates significantly. While the size of fiscal misses will be dependent on the path of front-month crude prices and the pace of a potential global recovery, particularly at risk are Gulf Cooperation Council (GCC) countries, which will be heavily impacted by lower energy prices. At the onset of the year, the market expected roughly $30 billion of GCC external debt issuance during 2020. However, we now anticipate issuance of as high as $80 billion, with Qatar and Abu Dhabi printing $17 billion just this past week!
Identifying a Value Opportunity
Much like recent trends in the US investment-grade market, we are expecting EM sovereign issuance to come with a significant concession for the foreseeable future, as exemplified by recent sovereign issues from Panama, Israel and Qatar. This opportunity is illustrated in Exhibit 2, which shows the historically high levels of credit spreads available in EM sovereign bonds, even exceeding stressed levels observed during the taper tantrum and the 2015 oil shock. Within the lower quality EM universe, we see significant divergence between issuers, with stressed credits such as Ecuador and Lebanon recently announcing restructurings, but BBB and BB rated credits watching for their opportunity to come to market as the post-virus recovery progresses.
Exhibit 2: EM Sovereign Investment-Grade Issuance
Source: JPMorgan. As of 08 Apr 20. Past performance is no guarantee of future results. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.
While we acknowledge that EM economies have unique exposure to both COVID-19 and the oil price crash, we still find value in the higher quality part of the market—a strategy that lines up with Western Asset’s recent views on value in the US investment-grade market. As with previous credit crises, we anticipate that the first deals back to the market will be the best, and Western Asset is poised to take advantage of this opportunity.
Find out more about Western Asset's Fixed Income solutions:
Legg Mason Western Asset Australian Bond Fund
Legg Mason Western Asset Cash Plus Fund
Legg Mason Western Asset Global Bond Fund
Legg Mason Western Asset Macro Opportunities Bond Fund
A credit spread is the difference in yield between two different types of fixed income securities with similar maturities, where the spread is due to a difference in creditworthiness.
“Taper tantrum” refers to the financial markets’ reactions, in May-August 2013, to the announcement by the Federal Reserve that it was planning to decrease, or “taper” its $70 bn per month bond buying program.
"2015 oil shock" refers to the rapid decline of the price of crude oil between the beginning of May to the end of January 2016, during wihich crude oil prices fell from as high as $67.77 to $27.88 (prices Source: Bloomberg, for ICE Brent crude oil).
The Organization of the Petroleum Exporting Countries (OPEC) is a permanent intergovernmental organization of 12 oil-exporting developing nations that coordinates and unifies the petroleum policies of its member countries.
OPEC+ includes the 11 OPEC members and 10 non-OPEC nations.
COVID-19 is the World Health Organization's official designation of the current coronavirus disease.
Emerging markets (EM) are nations with social or business activity in the process of rapid growth and industrialization. These nations are sometimes also referred to as developing or less developed countries.
Hard currency refers to a currency, usually from a highly industrialized country that is widely accepted around the world as a form of payment for goods and services.
Gross Domestic Product ("GDP") is an economic statistic which measures the market value of all final goods and services produced within a country in a given period of time.
An investment-grade (IG) rating (AAA, AA, A, BBB for example) is one that indicates that a municipal or corporate bond has a relatively low risk of default. Bonds with below investment-grade ratings (BB, B, CCC for example) are considered low credit quality and have a higher risk of default.
A BBB rating is the lowest investment-grade rating; it reflects an opinion that the issuer has the current capacity to meet its debt obligations but faces more solvency risk than A-, AA- or AAA-rated issues.
The A3/BBB+ credit bucket refers to an investment-grade level of creditworthiness on the low end of the credit quality spectrum.
The Gulf Cooperation Council (GCC) is a political and economic alliance of six countries in the Arabian Peninsula: Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the United Arab Emirates.
Forecasts are inherently limited and should not be relied upon as indicators of actual or future performance.
All investments involve risk, including possible loss of principal.
The value of investments and the income from them can go down as well as up and investors may not get back the amounts originally invested, and can be affected by changes in interest rates, in exchange rates, general market conditions, political, social and economic developments and other variable factors. Investment involves risks including but not limited to, possible delays in payments and loss of income or capital. Neither Legg Mason nor any of its affiliates guarantees any rate of return or the return of capital invested.
Equity securities are subject to price fluctuation and possible loss of principal. Fixed-income securities involve interest rate, credit, inflation and reinvestment risks; and possible loss of principal. As interest rates rise, the value of fixed income securities falls.
International investments are subject to special risks including currency fluctuations, social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets.
Commodities and currencies contain heightened risk that include market, political, regulatory, and natural conditions and may not be suitable for all investors.
Past performance is no guarantee of future results. Please note that an investor cannot invest directly in an index. Unmanaged index returns do not reflect any fees, expenses or sales charges.
The opinions and views expressed herein are not intended to be relied upon as a prediction or forecast of actual future events or performance, guarantee of future results, recommendations or advice. Statements made in this material are not intended as buy or sell recommendations of any securities. Forward-looking statements are subject to uncertainties that could cause actual developments and results to differ materially from the expectations expressed. This information has been prepared from sources believed reliable but the accuracy and completeness of the information cannot be guaranteed. Information and opinions expressed by either Legg Mason or its affiliates are current as at the date indicated, are subject to change without notice, and do not take into account the particular investment objectives, financial situation or needs of individual investors.
The information in this material is confidential and proprietary and may not be used other than by the intended user. Neither Legg Mason or its affiliates or any of their officer or employee of Legg Mason accepts any liability whatsoever for any loss arising from any use of this material or its contents. This material may not be reproduced, distributed or published without prior written permission from Legg Mason. Distribution of this material may be restricted in certain jurisdictions. Any persons coming into possession of this material should seek advice for details of, and observe such restrictions (if any).
This material may have been prepared by an advisor or entity affiliated with an entity mentioned below through common control and ownership by Legg Mason, Inc. Unless otherwise noted the "$" (dollar sign) represents U.S. Dollars.
This material is only for distribution in those countries and to those recipients listed.
All investors and eligible counterparties in EU and EEA countries:
In Europe (excluding UK and Switzerland), this financial promotion is issued by Legg Mason Investments (Ireland) Limited, registered office Floor 6, Building Three, Number One, Ballsbridge, 126 Pembroke Road, Ballsbridge, Dublin 4. D04 EP27, Ireland. Registered in Ireland, Company No. 271887. Authorised and regulated by the Central Bank of Ireland.
In the UK, this financial promotion is issued by Legg Mason Investments (Europe) Limited, registered office 201 Bishopsgate, London EC2M 3AB. Registered in England and Wales, Company No. 1732037. Authorized and regulated by the UK Financial Conduct Authority.
In Switzerland, this financial promotion is issued by Legg Mason Investments (Switzerland) GmbH.
Investors in Switzerland: The representative in Switzerland is FIRST INDEPENDENT FUND SERVICES LTD., Klausstrasse 33, 8008 Zurich, Switzerland and the paying agent in Switzerland is NPB Neue Privat Bank AG, Limmatquai 1, 8024 Zurich, Switzerland. Copies of the Articles of Association, the Prospectus, the Key Investor Information documents and the annual and semi-annual reports of the Company may be obtained free of charge from the representative in Switzerland.
All Investors in Hong Kong and Singapore:
This material is provided by Legg Mason Asset Management Hong Kong Limited in Hong Kong and Legg Mason Asset Management Singapore Pte. Limited (Registration Number (UEN): 200007942R) in Singapore.
This material has not been reviewed by any regulatory authority in Hong Kong or Singapore.
All Investors in the People’s Republic of China (“PRC”):
This material is provided by Legg Mason Asset Management Hong Kong Limited to intended recipients in the PRC. The content of this document is only for Press or the PRC investors investing in the QDII Product offered by PRC’s commercial bank in accordance with the regulation of China Banking Regulatory Commission. Investors should read the offering document prior to any subscription. Please seek advice from PRC’s commercial banks and/or other professional advisors, if necessary. Please note that Legg Mason and its affiliates are the Managers of the offshore funds invested by QDII Products only. Legg Mason and its affiliates are not authorized by any regulatory authority to conduct business or investment activities in China.
This material has not been reviewed by any regulatory authority in the PRC.
Distributors and existing investors in Korea and Distributors in Taiwan:
This material is provided by Legg Mason Asset Management Hong Kong Limited to eligible recipients in Korea and by Legg Mason Investments (Taiwan) Limited (Registration Number: (109) Jin Guan Tou Gu Xin Zi Di 016; Address: Suite E, 55F, Taipei 101 Tower, 7, Xin Yi Road, Section 5, Taipei 110, Taiwan, R.O.C.; Tel: (886) 2-8722 1666) in Taiwan. Legg Mason Investments (Taiwan) Limited operates and manages its business independently.
This material has not been reviewed by any regulatory authority in Korea or Taiwan.
All Investors in the Americas:
This material is provided by Legg Mason Investor Services LLC, a U.S. registered Broker-Dealer, which includes Legg Mason Americas International. Legg Mason Investor Services, LLC, Member FINRA/SIPC, and all entities mentioned are subsidiaries of Legg Mason, Inc.
All Investors in Australia and New Zealand:
This document is issued by Legg Mason Asset Management Australia Limited (ABN 76 004 835 839, AFSL 204827). The information in this document is of a general nature only and is not intended to be, and is not, a complete or definitive statement of matters described in it. It has not been prepared to take into account the investment objectives, financial objectives or particular needs of any particular person.