The Zhitong Finance App learned that investors in the bond market seem to be shifting from US Treasury bonds with higher security levels to emerging market corporate bonds with a higher risk factor. The data shows that the Bloomberg Emerging Markets Corporate Debt Price Index in US dollars has rebounded sharply since October last year, reaching the highest level since February 2022, achieving double-digit returns. This reduced its yield premium on US Treasury bonds to 216 basis points, less than half of the 2022 spread (the lower the yield, the higher the bond price). A similar indicator shows that interest rates on debt issuance and borrowing by emerging market companies are only 133 basis points higher than their American peers.

However, investors are not deterred by such a low risk premium on bonds and are betting on a further rise in emerging market corporate bonds. They said that from the perspective of total return on investment in bonds, the yield index for emerging markets is high enough. Once the Federal Reserve begins to relax its policy and global borrowing costs fall, locking in revenue streams that were once close to 7% in emerging markets will be more attractive. They also said that technical factors, from shortening the average lifespan to the limited supply scale of new bonds, are also driving institutional demand for these emerging market bonds.

In particular, after the release of the US CPI data for April, which was in line with expectations, and the recently announced number of jobless claims at the beginning of the week suggests that the US labor market is sluggish. The market's expectations for the Federal Reserve's interest rate cut in 2024 have heated up sharply, from the “no interest rate cut” expectations that the market had set in April to cutting interest rates 2-3 times recently.

The CME “Federal Reserve Watch Tool” shows that interest rate futures traders are betting that the Federal Reserve will cut interest rates for the first time in September rather than the first rate cut in December, and traders' pessimistic expectations of “no interest rate cut during the year” fell from once in April to around 50 basis points - 75 basis points.

Global capital raps up emerging market corporate bonds

Arnaud Boué, executive director and senior fixed income portfolio manager at Bank of Zurich, said, “Even if the spread is small, the overall valuation is relatively attractive if investors consider spread trading strategies.” “As investors seek potentially high-yield bonds with higher yields, when the Federal Reserve actually starts cutting interest rates, we are likely to once again see growing demand for emerging market corporate bonds.”

Deteriorating risk and return - investors are collectively pouring into the emerging market bond market, causing the yield on emerging market corporate bonds to drop markedly

Although the overall appeal of emerging markets is still overshadowed by the possibility that the Federal Reserve may delay the timing of interest rate cuts, the slowdown in economic growth in emerging markets, and high yields on US Treasury bonds, the associated scale of rush purchases of various dollar-priced assets is driving demand for hard currency corporate bonds around the world (including emerging markets dominated by developing countries).

This corporate bond boom has also been echoed in the primary market. So far this year, emerging market companies have raised up to 131 billion US dollars, an increase of about 33% compared to the same period in 2023. However, the size of newly issued US dollar bonds did not keep up with the maturing of corporate bonds, which supported the continuous rise in the price of existing corporate bonds, thereby providing a driving force for capital to buy corporate bonds in emerging markets. Luke Codrington, co-head of emerging markets global fixed income at Pinebridge Investments in London, said that in the past two years, the net financing amount of emerging market companies has been negative at US$413 billion.

“The narrowing of interest spreads is mainly driven by factors such as limited supply, relatively strong fundamentals, and reduced election risks.” Codrington display. “In addition to these factors, we are also seeing an optimistic outlook for sovereign credit in most emerging markets, which has led to a limited downgrade in the ratings of sovereign market-driven emerging market companies.”

At the height of the sovereign debt crisis two years ago, dollar bonds of emerging market companies became popular. At the time, their average yield was close to 10%. Investors, frightened by the risk of the local currency, sought to buy more secure US bond assets. After receiving bailouts from the International Monetary Fund (IMF) and other lenders, the rise in emerging market corporate bonds has continued to intensify over the past six months as the risk of default in the most vulnerable countries has decreased.

Fund manager Elizabeth Bakarich from AllianceBernstein said: “After poor performance in the last few months of 2023, interest spreads on emerging market corporate bonds began to catch up with US companies this year.” She said that technical factors such as the short average term of emerging market bonds (about 4.74 years, while the average term of US corporate bonds is about 6.87 years) have contributed to the recent excellent performance.

Emerging market sovereign debt performance supports emerging market companies

However, the fervor in the corporate bond market has worried a small number of institutional investors. They said that in the face of worsening global markets, ignoring risk spreads in the bond market and chasing nominal yields too much may be a dangerous move. Peter Varga of Erste Asset Management, one of the largest fund management companies in China and Europe, described the current bond market as a “broken market.”

“When I started my career in 2000, I learned to compare interest spreads to investment risks,” Varga said in an interview in Vienna. He is a senior portfolio manager in Vienna. “Now I'm seeing negative news in the market being ignored, investment leverage is rising, and no one really cares. Liquidity premiums of any kind have been ruled out. People just buy absolute returns and don't care about fundamentals.”

Although US Treasury yields have returned to a high level, and the money market postponed the possibility of the Fed's interest rate cut from June to December, the rise in emerging market corporate bonds does not seem to have been significantly affected. Some investors say they are optimistic about these securities because the global economic and monetary landscape will improve regardless of the Federal Reserve's position.

Paul Greer, fund manager of Fidelity International (Fidelity International) in London, said: “The repricing of expectations of interest rate cuts by the Federal Reserve did not damage the market's confidence in buying emerging market corporate bonds, because the US and global economic growth is far better than previous pessimistic market expectations, and concerns about a 'hard land' in the US and other emerging market economies have been mitigated.” “The positive performance of emerging market sovereign debt has also supported emerging market companies, providing strong fundamental support for emerging market corporate bonds. Many countries issuing high-yield bonds in emerging markets are implementing important macroeconomic reforms and fiscal improvement measures.”

As it stands now, for investors in the bond market, the general improvement in fundamentals of emerging market companies and market momentum and technology dynamics seem more important than the narrowing of the gap.

Omotunde Lawal, head of credit for emerging markets companies from Baring Investment Services (Bering Investment Services), said: “Capital is being reallocated from money market funds to developed market investment-grade asset classes, and this trend is driving cross-demand in certain areas of emerging market companies.” “Overall, the fundamentals of emerging market companies are also very healthy; therefore, we should see some degree of investment resilience unless there are special fluctuations or significant geopolitically-driven fluctuations.”