For all "doom and gloom" predictions of an imminent crash in Emerging Markets (here and here, among many others), not only have these not materialized, but as of last week the average yield on corporate junk bonds issued by emerging markets dropped to 5.53% late last week, the lowest on record, according to the WSJ citing J.P. Morgan. Indicatively, two years ago, that yield was over 9%.
For a case study of the yield-chasing insanity unleashed by central bankers, look no further than Tajikistan.
The central Asian country last month raised $500 million in its first-ever international bond sale, paying just 7.125% in annual interest on the debt after the U.S.-dollar offering drew a swarm of American and European buyers. Bankers had earlier shopped the 10-year bonds from the former Soviet satellite with an 8% yield, which was pulled down by strong investor demand.
The reason for the scramble into any piece of yielding debt, even Tajik junk bonds is simple: as the IMF shows today in its latest financial stability report, there are virtually no IG bonds left with yields above 4%, and in the junk bonds space, whether in the US or offshore, it isn't much better.
But whatever the reason (and, spoiler alert, central bank and especially ECB nationalization of the bond market is what is causing this), the outcome is clear, and as the WSJ notes, "investors’ thirst for income is enabling governments and companies in some of the world’s poorest countries to sell debt at lower and lower interest rates. Greece, which was on the brink of default a few years ago, issued new bonds this past summer, and the country’s National Bank launched a bond sale Tuesday, marking the return of Greek banks to the credit markets since the country’s sovereign-debt crisis."
The numbers are staggering, junk bond issuance in the developing world has hit a record $221 billion this year, already up 60% from the full-year total in 2016.
For buyers, the numbers don't matter however: the justify the record purchases by claiming that the debt "pays a healthy yield and carries few immediate risks." Furthermore, they claim that "the global economy appears robust and emerging-market defaults are low. Bankers say they expect emerging markets to sell tens of billions of dollars in new junk bonds by year-end."
And why not: with billions in IG debt yielding negative, and "high yield" having become a laughable misnomer, investors desperate for any yield will go wherever it exists.
Even in Tajikistan.
Still, the euphoria is worrying some investors, who warn that frenzied buying of risky assets sometimes presages market turning points. One such worrier is Wilbur Matthew of Vaquero Global Investments, who told the WSJ that “while I am not shouting the end is near, it is normally pretty far down the line that emerging markets start to see this type of euphoria.” He said he has been selling some riskier debt to buy higher-rated bonds and securities that mature sooner.
But back to Tajikistan's oversubscribed issuance: its bonds were rated B- by S&P, with the ratings firm estimating the country’s GDP per capita at $900, putting it among the lowest of the sovereign nations it rates, but said it sees Tajikistan’s growth prospects improving gradually. Of course, that sale followed the previously discussed June bond-market debut of the Maldives, a tiny nation in the Indian Ocean that raised $200 million in a sale of five-year bonds with a 7% coupon.
“Investors are very bullish on bonds from emerging markets and very keen to diversify into new names,” said Peter Charles, a Citibank managing director who handled the Tajikistan bond sale. The country plans to use some of the proceeds to finance a power plant project.
To be sure, not everyone rushed at the opportunity to hand over other people's money to some of the world's poorest, most corrupt nations:
Samy Muaddi, who manages a portfolio of emerging-market bonds at T. Rowe Price Group , said he didn’t buy the Tajikistan debt because he lacked information about the country’s repaying history and financial strength. “We are seeing a lot of aggressively priced deals, as many new entrants are coming to the market with less-established track records,” he added. T. Rowe has about $16 billion in emerging-market debt.
Poor Samy: he will likely be fired at the end of the year for being "too prudent and conservative."
Meanwhile, at the corporate level, it is an absolute feeding frenzy, and companies that previously struggled to raise money in the credit markets had no trouble doing so recently. Geo Energy Resources, an Indonesian coal-mining group, canceled a $300 million bond sale in July when investors were demanding a yield of close to 9%. In late September, the company returned to the markets and sold the bonds with an 8.3% yield.
But wait, it gets better: "even issuers with a history of defaults have been able to find buyers for their debt. Argentina in June sold 100-year bonds, even though the South American nation has defaulted multiple times over the past few decades."
And some more narrative goalseeking by those who participated:
“We’re at a part of the credit cycle globally that’s really benign. Risk-taking is really high,” said Jay Wintrob, CEO of Oaktree Capital Management, during a recent visit to Hong Kong. Los Angeles-based Oaktree has $99 billion under management in corporate debt and other investments.
Unlike Samy, Jay will collect a hefty bonus this year: after all he traded alongside the central banks, who have made a mockery of what Bill Gross called "fake", manipulated markets.
Adding insult to injury for those who still hold financial logic in high regard, "prices of emerging-market junk bonds have gained sharply this year, pushing their “spreads,” or the additional yield that investors demand over interest-rate benchmarks, to multiyear lows. That spread over U.S. Treasurys was just 3.48 percentage points at the end of last week, the tightest level in 10 years, according to J.P. Morgan. A year ago, the spread was 5.3 percentage points."
Buyers of such bonds have been collecting hefty returns. A J.P. Morgan index that tracks high-yield corporate bonds in the emerging markets has risen 9.2% this year through September, significantly outperforming U.S. junk bonds, which have returned 6.7% over the same period.
And while one can justify such purchases until one is blue in the face, claiming "synchronized global growth", improving balance sheets, or simply central bank herding, the reality is that - as we have discussed before - buyers of bonds issued by low-rated companies and countries in the emerging world could be exposed to multiple risks should markets turn.
In previous times of market stress and economic weakness, junk bonds and emerging-market debt were among the asset classes that suffered sharp price declines as investors dumped riskier holdings for safer ones. The recent tightening in spreads raises questions about whether investors are getting adequately paid for the risk they are taking on. A faster-than-expected interest-rate hike by the Federal Reserve could also hurt bonds broadly, because bond prices fall when rates and yields rise.
Even so, almost nobody is concerned: "Polina Kurdyavko, co-head of emerging-market debt at BlueBay Asset Management, a fixed-income firm with $57 billion of assets under management, said she isn’t worried yet. Junk bond issuance, which makes up less than half of overall emerging-market debt supply, has so far been increasing proportionally to the broader sector."
“I’ll start worrying when high yield dominates new bond issuance in emerging markets,” she said.
There may be a simpler catalyst: the end of central bank liquidity injections.
As Deutsche Bank's chief macro strategist Alan Ruskin said earlier today...
"As we look at what could shake the panoply of low vol forces, it is the thaw in Central Bank policy as they retreat from emergency measures that is potentially most intriguing/worrying. We are likely to be nearing a low point for major market bond and equity vol, and if the catalyst is policy it will likely come from positive volatility QE ‘flow effect’ being more powerful than the vol depressant ‘stock effect’. To twist a phrase from another well know Chicago economist: Vol may not always and everywhere be a monetary phenomena – but this is the first place to look for economic catalysts over the coming year."
Ruskin is right, of course, but where he is wrong is the assumed reaction by central bankers: having cultivated the 'wealth effect' for the 1% for nearly a decade, will central banks suddenly turn their backs on the capital markets, their primary "wealth expansion pipeline", and see the fruit of their labor crushed? Judging by the record low volatility and credit spreads, and record high stocks, the market's verdict is simple: never.