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EM bond spreads at record lows

February 07, 2007 | Financial Times

Risk premiums on emerging market bonds on Tuesday were close to record lows as hopes of a credit rating upgrade for Brazil spurred another round of buying.

As bond prices rose, the risk premium on emerging market bonds, as measured by JPMorgan’s EMBI+ index, a market barometer, touched an intraday low of just 164 basis points over US Treasuries during trading. The lowest close for the index – 165bp over US Treasuries – was reached on Friday.

Fitch Ratings on Monday night revised the outlook for Brazil’s BB external credit rating from stable to positive, bringing it in line with Standard & Poor’s outlook on the country. The move helped compress risk premiums for the bonds of Brazil, a benchmark credit, fuelling bullish sentiment across the emerging market debt market.

“The rapid improvement in Brazil’s external balance sheet, notably its shift in 2006 to being a net public external creditor, raises the likelihood of an upgrade over the next two years . . . as long as public finances do not deteriorate,” said Roger Scher, managing director for Latin American sovereign ratings at Fitch.

“Brazil is an outlier relative to peers in terms of its government debt burden,” he added, “and robust primary surpluses as well as structural reforms that would release the country’s growth potential are needed to get the debt to GDP ratio on a rapid downward trajectory.”

Philip Poole, head of emerging markets research at HSBC, said the rating agency’s move made sense. “Despite residual concerns about the quality of the fiscal adjustment, Brazil is well on track for an upgrade. This is overall positive for emerging markets. Brazil is still the touchstone for the market.”

Despite jitters in the market last month as oil prices retreated, investor appetite for emerging market debt has remained robust since the beginning of the year when the EMBI+ index was at 169bp over US Treasuries.

In the next few days, trading may be muted. “Given this week’s light data calendar in the US, emerging market debt is likely to trade range-bound for the remainder of the week, and investor focus will turn to a full slate of [US Federal Reserve] speeches,” said JPMorgan.

However, risk premiums are expected to continue heading lower this year. Yield-hungry investors are pouring money into emerging market assets at a time when the supply of sovereign paper is on the decline. Financially stronger governments are issuing less debt while buying back old bonds. And investors are scooping up bonds of emerging market companies and banks instead, among the fastest growing segments in emerging markets.

In recent weeks, there has been particularly heavy issuance of bonds by companies from the former Soviet Union and the Middle East. “The new issue machine is rolling along,” said Jim Croft, an emerging markets debt trader at Commerzbank.

According to research from JPMorgan, new issuance in the corporate sector rose to $111bn in 2006 from $26bn in 2001. “By the end of this year, we predict that the size of the corporate bond market will be virtually double the size of the external debt market,” analysts said.


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