Our favourites: China, Russia, India and Mexico
The biggest reason we don't like EM sovereign bonds lies in the recent rise in US Treasury yields. Yields are rising in the United States because inflation expectations are rising. Although the Federal Reserve will ignore a real rise in inflation by keeping monetary policies easy, the US yield curve will steepen. A steeper US yield curve poses a severe refinancing threat to the developing world.
At the end of last year, we built an "EM distressed monitor”, trying to understand which countries were posing a more considerable risk to bondholders. Today, we update that chart to understand which countries offer the greatest risk.
We find that market sentiment has improved across all EMs except for Argentina, in which CDS spreads have widened. It matches our findings above, which show that the average EM OAS over US Treasuries has tightened. Secondly, we see that in 2020 nearly all countries increased their debt-to-GDP ratio. Finally, each one of these countries' central bank has engaged in accommodative monetary policies.
Expansionary monetary policies in the EM can be a double edge sword. On one side, it supports internal markets; on the other, it provokes a devaluation of the local currency, which can prove extremely dangerous during an environment of rising interest rates. However, it must be said that countries with ample international reserves can engage in accommodative monetary policies without significant problems. That's the case of our favourite EM: China, India, Russia and Mexico.
The countries that prove the riskier, on the other hand, have low international reserves, a high debt-to-GDP ratio and have engaged in aggressive monetary policies. These countries can be found at the right end of the chart below.