What does the Polish upgrade say about EM?

Bonds 6 minutes to read

Althea Spinozzi

Fixed Income Specialist, Saxo Bank Group

Summary:  Poland's recent FTSE Russell upgrade to developed market status may lead investors to take another look at the emerging market space, but EM troubles are not over yet.


Summer is clearly coming to an end. In the Nordic countries, the days are shorter, the breeze is a few degrees colder, and in Denmark people are lighting candles to ensure a hyggelig autumn.

Investors are also welcoming the new season after an intense summer that saw the bond market appearing to be on the verge of collapse on news of a developing crisis in emerging markets and an intensifying trade war between the US and some its largest trade partners, most notably China.

Fixed income is now at something of a standstill as investors wait to see if thing will worsen further before getting rid of their riskier assets.

It is clear that the lessons imparted by Turkey and Argentina just a few weeks ago were not particularly well-absorbed. Risk sentiment remains carelessly robust as investors seek relative value in lower-hanging fruits within the EM and the high yield spaces.

Their comfort comes from a financial sphere that seems determined to insist all is OK, even within the same EM space that so recently appeared to be coming apart at the seams.

The FTSE Russell has promoted Poland to “developed market” status, the first such new addition to these ranks in nearly a decade. It is certainly true that Poland has been one of the fastest-growing economies in Europe for the past few years, but its economic and fiscal performance has been tied very closely to the European Union’s post-financial crisis recovery. 

The obvious question here, I think, is whether Poland’s developed’ status exists upon a strong enough political and economic base to justify the term.

On Monday, and just as Poland was receiving its upgrade, the EU brought the country to court on charges that the right-wing government in Warsaw is violating judicial independence by setting an earlier retirement age for Supreme Court judges. The move was controversial, and even sparked protests in Poland, as some believe that such reforms enable the current regime power to overrule the Polish judiciary.

It is clear that although the country has achieved impressive economic development over the past few years, there are still issues within the political sphere that may cause a reversal, pushing it again towards EM status.

Nevertheless, now that the FTSE Russell has upgraded Poland, a broader base of investors will have access to the country’s financial market and this will boost the valuation of Polish sovereigns. The 10-year Polish Zloty-denominated government bond has a yield of  3.22%, down 60 bps from January 2017. 

The space that will benefit the most in the medium term is the Polish corporate space as companies will face lower costs of capital, hence we can expect more issuances in this space until the global economic backdrop changes between 2019/2020.

At that point, we fear certain contradictions within EMs will put further pressure on this space; when the economic cycle shifts into recession, EM sovereigns and corporates will be the first casualties.

It is not just Poland that illustrates this point, as even China is currently bringing a valuable lesson to the table. 

As many of you already know, one of the main topics within EM this year has been Beijing’s intent to deleverage its economy. At the same time, however, we see local governments planning to issue ‘special-purpose’ bonds totaling $200 billion. These bonds will be issued to fund infrastructure investment amidst a slowing economy. In this case, the worst thing may not be the fact that the Chinese government will increase its overall debt-to-GDP ratio, which already totaled 51% at the end of December 2017, but rather that this debt will mainly be absorbed by Chinese banks as these bonds will provide a low yield and will remain very illiquid, rendering them unappealing to real money.

This will add illiquid government debt to the Chinese financial sector’s already weak balance sheet, posing a great threat to the financial system as a whole. If things continue on their present path, however, one could maintain that the current, fragile equilibrium may continue for some time, thus making it more appealing to stay invested rather than waiting for a potentially distant downturn.
In this environment we believe that certain types of bonds allow investors to stay invested while selecting for specific risks while the economic backdrop changes. 

Many have been expecting a downturn for some time now, and investors who bet heavily on an equities decline over the past earnings season were hit hard by new highs. This is why it is crucial to enter these types of trade at the right time while remaining invested in more conservative assets which can remain resilient amid a sudden market collapse.

The investment grade space, excluding the BBB space in the US, offers exciting opportunities in keeping with this point of view, but for investors looking for short-term maturities (up to the end of 2019) there might be also opportunities in high yield US and selected EM corporates.
 

Disclaimer

The Saxo Bank Group entities each provide execution-only service and access to Analysis permitting a person to view and/or use content available on or via the website. This content is not intended to and does not change or expand on the execution-only service. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Bank Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Bank Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Bank Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Bank Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.

Please read our disclaimers:
- Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
- Full disclaimer (https://www.home.saxo/en-gb/legal/disclaimer/saxo-disclaimer)

Saxo Markets
40 Bank Street, 26th floor
E14 5DA
London
United Kingdom

United Kingdom

Trade Responsibly
All trading carries risk. To help you understand the risks involved we have put together a series of Key Information Documents (KIDs) highlighting the risks and rewards related to each product. Read more
Additional Key Information Documents are available in our trading platform.

Saxo Markets is a registered Trading Name of Saxo Capital Markets Ltd (‘SCML’). SCML is authorised and regulated by the Financial Conduct Authority, Firm Reference Number 551422. Registered address: 26th Floor, 40 Bank Street, Canary Wharf, London E14 5DA. Company number 7413871.

This website, including the information and materials contained in it, are not directed at, or intended for distribution to or use by, any person or entity who is a citizen or resident of or located in the United States, Belgium or any other jurisdiction where such distribution, publication, availability or use would be contrary to applicable law or regulation.

It is important that you understand that with investments, your capital is at risk. Past performance is not a guide to future performance. It is your responsibility to ensure that you make an informed decision about whether or not to invest with us. If you are still unsure if investing is right for you, please seek independent advice. Saxo Markets assumes no liability for any loss sustained from trading in accordance with a recommendation.

Apple, iPad and iPhone are trademarks of Apple Inc., registered in the U.S. and other countries. App Store is a service mark of Apple Inc. Android is a trademark of Google Inc.