Investors are gobbling up bonds in emerging markets around the world so rapidly that the risk premium on them has dropped dramatically, reports an article in Bloomberg. The rebound is being led by countries that were on the edge of default only months ago, such as Pakistan, Ghana, and Ukraine. Inexpensive, high-yield, emerging markets bonds “look more attractive relative to investment grade,” Ben Luk of State Street Global Markets told the news outlet. In addition, commodities—particularly oil—could generate enough cash flow to stave off any sovereign default in the short term.
Defaults were widely predicted as part of the aftermath of Russia’s invasion into Ukraine, but they didn’t happen. Most countries have kept up with their debts and even negotiated deals with the International Monetary Fund. That’s given investors confidence to turn back to bonds, fueling the rally. And the “risk of distress is still being heavily priced in” to declines in dollar-debt yields for Egypt and Nigeria, wrote analysts at Tellimer in a note that’s cited in the article. As risk sentiment turns optimistic, a “window of opportunity for outperformance in selected emerging-market assets” has flung open, the Tellimer analysts maintain, while also advising caution against diving back into more distressed nations such as Ghana and El Salvador.
But even amidst the lows in risk premiums, some smaller emerging markets still have a ways to go before they can sustain their national debt for the long term—something that investors should consider as they look ahead to 2023. Furthermore, many countries have seen their credit ratings fall as debt rose during the pandemic; over half the sovereign nations in Africa, the Middle East, Latin America and the Caribbean have B ratings or lower, according to Moody’s. That means the risk of default in those countries goes up, particularly in countries where funding needs are especially high or large debts are due to mature in the next few years—Ghana, Pakistan, Tunisia, Nigeria, Ethiopia, and Kenya among them, the article details.
Still, as hopes for an easing in the Fed’s tightening policy and optimism amid the batch of IMF deals abounds, investors are jumping on high-yield bonds, which Bloomberg estimates has gone up about 7% since September. “There are very attractive yields, especially if one can look through short-term volatility periods that…will still happen from time to time,” Guido Chamorro of Pictet Asset Management told Bloomberg.