EM Bonds: Getting Paid

Mid Week Bond Update

EM Bonds: Getting Paid

Some EM countries are less vulnerable than others to foreign creditors; U.S. High Yield spreads rise, along with returns; Eurozone PMIs are on the downswing.

EM Bonds: Getting Paid

Investors in Emerging Market (EM) debt rightly focus on daily mark-to-market prices of bonds they own or are considering buying.  Close attention is also paid to both internal and global politics, watching for any signals of capital controls, nationalizations and/or government instability.

But these factors are ultimately subject to the bottom-line question of credit quality -- whether the issuer will pay the interest and return the principal as promised.

One useful method of assessing the likelihood of repayment is a composite developed by Haver Economics, used to good effect in Brandywine Global’s: What's the Catch, Indonesia?

That measure, dubbed the External Vulnerability Ratio, attempts to capture the main measurable factors affecting a country’s position relative to foreign creditors by taking the sum of its liabilities and dividing that by the country’s official foreign exchange reserves.

Financial Pressure: Some EM Economies are More Exposed than Others

External Vulnerability Ratios* for Selected EM Countries

Chart courtesy of Brandywine Global.  Source: Haver Analytics, as of 12/31/2018. * Note: External Vulnerability Ratio is calculated by Haver Analytics as: (Short-term External Debt + Currently Maturing Long-Term External Debt + Total Nonresident Deposits Over One Year)/Official Foreign Exchange Reserves (%). 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.


As the chart shows, by this measure the net exposure of Indonesia appears well below that of Turkey, Argentina and South Africa – a surprise for investors holding an outdated vision of the country’s progress.

Granted, the Indonesian rupiah was hit hard in 2015 along with other EM currencies, and was under pressure again during 2018 as investors fled EM currencies and bonds.

But as Brandywine notes, Indonesia’s underlying economics are substantially stronger than they were even two years ago. One important example: its central bank lost little time boosting interest rates to stave off the inflation that has plagued other EM economies whose central banks are less disciplined.

On the rise:  US High Yield

By one measure, the market for U.S. High Yield Corporates was relatively indifferent to the Fed’s dovish turn at the end of January: spreads to U.S. Treasuries continued their upward move since the end of 2018, reaching 411 bps1 as of February 4.  The standard interpretation would be that the market perceives a slight rise in credit risk, due to a potentially slowing U.S. economy or soft corporate earnings.

But in fact the overall HY index also rose – some 4.8% on a total return basis between December 31 and February 4, at the same time that spreads widened.  For now, it seems that desire for higher yields may be outrunning the implicit credit risks in the high-yield corporate market.

Add to the mix the S&P 500’s year-to-date rise of more than 9.5% as of the close February 4; equity investors appeared to focus more on the positives of the Fed’s decision for corporate borrowers rather than as a sign of trouble ahead.

On the slide: Euro-area PMIs

Still slightly above the zero-growth index level of 50, the composite PMI for the Eurozone now stands at 51, a low not seen since mid-2015. Of the three largest economies, only France’s PMI is below 50, having dropped from December’s 48.7 to 48.2 for January. Germany’s composite PMI showed signs of life in January, despite difficult GDP numbers, rising to 52.1.

The UK’s numbers, however, have been falling, albeit unevenly, since June 2018 – now just above breakeven at 50.1. With Brexit generating concern among the purchasing managers responsible for keeping goods and services flowing in an uncertain transportation and regulatory environment, the potential is there for PMIs for the UK to get worse before getting better.



1 As measured by the The Bloomberg Barclays U.S. High-Yield Bond Index, which covers the universe of fixed-rate, non-investment grade corporate debt of issuers in non-emerging market countries. 


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.

A spread is the difference in yield between two different types of fixed income securities with similar maturities or other comparable characteristics.

A basis point (bps) is one one-hundredth of one percent (1/100% or 0.01%).

The S&P 500 Index is an unmanaged index of 500 stocks that is generally representative of the performance of larger companies in the U.S.

The Bloomberg Barclays U.S. High-Yield Bond Index covers the universe of fixed-rate, non-investment grade corporate debt of issuers in non-emerging market countries.

Purchasing Managers Indexes (PMI) measure the manufacturing and services sectors in an economy, or a composite of the two, based on survey data collected from a representative panel of manufacturing and services firms. PMI greater than 50 indicated economic expansion; below 50, contraction.



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