Why EM bonds are a bridge too far
Investors are flocking to emerging market bonds amidst the current risk-on-rally, but elevated yields do not always compensate for the true risks involved.
Fixed Income Specialist, Saxo Bank
For many, this is the first week back at work after a relaxing summer holiday. As such, I feel it is our duty to be clear on what is happening in the market: this is the beginning of the long-awaited crunch caused by the same money that so aided the old and new world during the 2008-7 crisis.
The only difference this time is that the narrative contains no real ‘bad guys’ (read: Lehman et al.). Instead, we have a bunch of ‘good guys’ whose good intentions have allowed a potentially explosive situation to develop.
Help without a clear recovery path
Since the financial crisis and the 2013 European peripheral debt crisis, the Federal Reserve and European Central bank have put an enormous amount of money into the system to avoid a domino effect of defaults that would ultimately see SMEs and weaker corporates cut off from financial markets.
This strategy worked well in one sense because the economy was able to recover; defaults decreased to historic lows and just when inflation started to pick up, central banks began to hike interest rates and discuss ending quantitative easing. Stopping QE, however, means that central banks need to disinvest the same money that has thus far supported equity and credit valuations. The hope is that the market won’t notice; the reality is that we cannot simply ‘rewind’ to pre-crisis circumstances and withdrawing this money will leave a huge hole in the market, making it more vulnerable to volatility.
We are just at the beginning of this balance sheet disinvestment plan (see figure one) and we are already seeing signs of distress arising from emerging markets. If this is the beginning of a crisis, will the Fed have enough ammo to manage a crunch?