Overview
If you needed any convincing that 2024 will be the year when investors turn en masse towards credit, then look no further than the issuance in the first two months of the year. The assumption after December that the Federal Reserve was done raising interest rates was the trigger for an avalanche of interest in a wide range of higher- yielding bonds and credit, and spreads across the board tightened.
Emerging market (EM) governments, which tend to frontload issuance in the first quarter, responded with the biggest release of dollar-denominated debt sales in 20 years - some USD $56 billion. Even after this flood of supply, demand continues to run at several times the volume on offer for most of these new bonds.
There are three trends worth noting. Firstly, at the same time as all the issuance, EM funds have been seeing outflows. Retail investors may still be reluctant to shift into emerging markets, given memories of post-Covid EM sovereign defaults that contrast with the perceived safety of cash and US equities.
Some weaker borrowers who didn’t have access to markets last year, such as Ivory Coast, Kenya, Montenegro and El Salvador, have already successfully issued bonds this year. More stressed countries may find it possible to test the market in the months ahead, leading to a virtuous cycle of increasing credit-worthiness and investor trust.
But if EM funds are not buying EM assets, then who is? This is what seem to be trends two and three: cross-asset investors chased out of developed market investment grade segments due to the extraordinary tightening of spreads (itself driven by a surge of inflows) are buying emerging paper, while at the same time domestic investors in increasingly wealthy home markets like eastern Europe or the Middle East are choosing to flex their financial muscles locally and diversify their fixed income holdings.
A note of caution
These last two trends suggest demand for both sovereign and corporate credit across the emerging market universe is unlikely to abate. It raises the question - do markets find themselves in a situation similar to that which existed in the lead up to the Global Financial Crisis, where there wasn’t enough credit supply to go round? We know how that ended.
More immediately, and while catching a breath at what are increasingly heady valuations across the board, the crowding out of some markets may soon push investors further down the quality spectrum in search of value.
The halt in the Fed’s moves towards cutting rates in the middle of this year may have put some of this process on hold. If US central bankers finally move ahead with interest rate cuts - or signal clearly that they will do so imminently - investors may become only more eager to look at emerging market bond funds.
An earlier version of this article appeared online in March, titled 'Chart Room: Overpriced, oversubscribed, but not over yet'.
