Alphaville’s Gwen Robinson has gotten
her hands on some research from CLSA’s Christopher Wood,
who foresees emerging-market debt yields even lower than the yields on US Treasury
bonds. I haven’t seen the research myself, but I hope it isn’t as confused about
the difference between yields and spreads as Robinson seems to be.
Robinson notes that Japanese bond yields fell below US bond yields in the 1970s,
and then adds:
This historic episode raises the issue today of the potential for emerging
market debt yields to trade eventually through US Treasury bond yields,
says Wood.
The possibility of such an outcome can no longer be dismissed out of hand,
he adds, “given the ability of emerging market debt spreads
to continue to decouple from rising credit spreads in the US”.
She does the spreads-to-yields switcheroo a second time, too:
His guess is that emerging market debt spreads “will suffer
a bit of a wobble if commodities are hit, most particularly the oil price”.
But if commodities remain strong, “the surprise will be that debt spreads
in the emerging area will keep declining whatever happens to CDOs, CLOs and
the like”.
Indeed, if structured finance “completely blows up”, Wood says,
“this could even lead to increasing demand for emerging debt given the
shrinking supply of such paper”. That is how emerging debt yields
could eventually trade through US Treasuries, in Wood’s view.
The elephant in the room that Robinson is so carefully dancing around, here,
is the whole question of currencies. In order to compare yields in yen to yields
in dollars, you first need to do a currency swap. And if you do that, you’ll
find that Japanese yields are, in fact, higher than US yields, just like they
always have been.
On a like-for-like comparison, nothing trades through US Treasuries, which
remain the gold standard, the risk-free benchmark. The only way that EM yields
will ever trade "through US Treasuries" is if you ignore the currency
component: that is, if you compare yields in Czech koruna, say, to yields in
US dollars. Which is no consolation at all to someone who goes short koruna
and long dollars in a carry trade, only to see the Czech currency soar against
the dollar.
On a nominal basis, it’s relatively easy for interest rates in an emerging-market
country to fall below interest rates in the US. All you need is for that country’s
central bank to set its own overnight rate at a level lower than the Fed funds
rate, and presto – at the short end of the curve, at least, that country
is "trading through Treasuries". Big deal.
But there is an important point here: emerging-market sovereign debt, which
has been trading through US high-yield debt for some time, now, could soon start
trading through US high-grade debt as well. That’s because the big borrowers
of old, like Argentina and Mexico, no longer issue dollar-denominated debt in
any significant quantity, so demand vastly exceeds supply.
Sovereign countries haven’t stopped defaulting, of course – just look
at the shenanigans in Ecuador. But most commodity-rich emerging-market countries
now lend much more to the US than they borrow from it. In
that context, it’s hardly surprising that their debt will remain attractive.
But EM spreads over Treasuries, if you look at dollar-denominated debt, will
never turn negative.