Living with several pending risk events, liquidity and risk appetite go with the territory
The fundamental environment in emerging markets remains stable. As the market has grown accustomed to living with several pending risk events, liquidity and risk appetite have been creeping back up. Buyers of emerging market mutual funds have been returning to the asset class after the commencement of the ECB’s version of QE.
Oil has rebounded from its lows, as the acceleration of future production cuts combine with an unprecedented ‘contango’ situation in the market. Brent future prices markedly higher than spot prices have lifted sentiment and attracted trading buyers.
Brent oil is expected to slowly trend back towards the second half of 2015 to an average of $70-75 per barrel. For now, it should remain in a $55-65 range, but this will not be enough to revive any inflation fears across Emerging Markets. This prospect is a good balance between the expected growth benefits to importers in Asia, Central Europe or Turkey, while removing the threat of extreme pressure on oil exporters, most of which have already seen a sizeable adjustment in their currency value.
Special situations like Petrobras, which affects about $55billion of debt, also need to be considered. The recent downgrade of the company to high yield, as much as a similar move on several key Russian corporates, should maintain a short-term technical cap on these assets, as the reaction of ‘buy and hold’ investment grade investors to these rating moves need to be kept a close eye on.
It should also be recognised that, in line with other ‘fallen angel’ cases, the worst spread performance tends to be mostly recorded before the downgrade to high yield occurs. Petrobras is so far no exception, having bounced strongly after the news. The noise on audited account and mild credit profile deterioration do not justify depressed valuations. Any write-offs should not exceed $20 billion and will not be as damaging for bondholders as it will largely be a non-cash item.
Fall in external debt
Russia has experienced recent hardships, but the RUB has stabilised for now, and risk-premia has trended down on the back of the recent uptrend in oil prices and after the recent ceasefire in Ukraine. The country is going through a repatriation of foreign assets, which explains a fall in external debt and a still-comfortable reserves position. This puts the country in ‘recovery mode’ despite the short-term hardships of recession and inflation.
Patience remains of the essence in this period of progressive recovery from the oil, Russia and Petrobras fallouts, but investment in Emerging Market fixed income needs to be considered before the full resolution of these uncertainties, in order to realise its value potential.
INFORMATION IS BASED ON OUR CURRENT UNDERSTANDING OF TAXATION LEGISLATION AND REGULATIONS. ANY LEVELS AND BASES OF, AND RELIEFS FROM, TAXATION ARE SUBJECT TO CHANGE.
THE VALUE OF INVESTMENTS AND INCOME FROM THEM MAY GO DOWN. YOU MAY NOT GET BACK THE ORIGINAL AMOUNT INVESTED.
PAST PERFORMANCE IS NOT A RELIABLE INDICATOR OF FUTURE PERFORMANCE.