The COVID-19 shock to the global economy has sent emerging markets debt (EMD) spreads to levels not seen since the global financial crisis. We believe this rise in EMD’s risk premium is overdone and underappreciates the fundamentals of the asset class, creating potential opportunities and an attractive entry point.
A Technical Sell-Off
Emerging market (EM) economic activity has collapsed amid the pandemic, along with economic activity globally. Before the current crisis, we were expecting gross domestic product (GDP) growth for the investable universe of the J.P. Morgan EMBI Global Diversified to be around 3.5% on average annually over the next two years. We now expect an average annual growth rate of slightly below 1%. We anticipate an extremely gradual and uneven recovery, likely with low-beta regions such as Asia leading the way and high-beta regions like Africa lagging.
Concerns about this worsening outlook and its potential negative implications for EMD creditworthiness led to unprecedented outflows from EMD funds during March and April of this year. Investors pulled out more than $40 billion from dedicated EMD funds over the three months ending April 24, as the chart below shows. Outflows from EMD funds moderated in May, and more recently we started seeing small inflows into hard currency EMD funds.
These outflows created massive forced selling pressures, especially among exchange-traded funds (ETFs), amid poor market liquidity conditions. This led to significant price decreases, especially in the less-liquid, higher-yielding part of the EMD market. These major price dislocations drove spreads to extremely high levels in a matter of days, and EMD underperformed other credit asset classes during this process. However, spreads have compressed around 100 basis points (bps) over the past month, reflecting better technical conditions driven by stable to marginally positive flows.
EMD fundamentals are certainly challenged by the global economic downturn. Yet the concerns about systemic risks that sparked the EMD outflows appear overblown, in our view.
We expect that EM default risk will be well contained going forward, given that the fundamental backdrop in most EM countries remains constructive. Overall levels of EM public debt are significantly below those in developed economies, growing only gradually over the last few years.
Improving liquidity conditions are supportive of EMD too. Current account balances have improved in recent years, and low inflation has enabled central banks globally to provide unprecedented monetary stimulus. This backdrop should keep the overall levels of global rates extremely low for a considerable period of time.
There also is ample multilateral and bilateral funding available for EMs. The IMF is able to lend about $1 trillion to its member countries and has been moving quickly and aggressively to provide liquidity support for EM countries in need. Meanwhile, the G-20 has approved a debt relief program for low-income EM countries, and the banking sector in most EM countries appears very solid, with high levels of capitalization.
The favorable liquidity environment and ample funding availability limit the scope for widespread technical defaults and should help contain a debt crisis in EMs.
The favorable liquidity environment and ample funding availability limit the scope for widespread technical defaults and should help contain a debt crisis in EMs, in our view. We see credit events limited to a handful of countries, most of them are already headed in that direction.
We find current EMD risk premiums overstate the credit risk relative to other fixed-income asset classes and to historical levels, implying an unrealistic probability of default. As a result, we see scope for EMD spreads to compress over the medium term, as normalizing market conditions may send EMD prices higher and yields lower.
Technical conditions—including high volatility and expensive transaction costs—have likely kept some investors from coming back to the EMD market so far. However, EMD outflows have moderated significantly recently, and there was very strong primary-market activity in April, with more than $55 billion in EMD issued in April and close to $30 billion issued so far in May. The strong demand for EMD bonds in the primary market reflects what we believe is the attractive valuation of the asset class.
A considerable portion of the investible EMD universe is currently trading below what we perceive to be fair value.
Against this backdrop, current valuations appear attractive. A considerable portion of the investible EMD universe is currently trading below what we perceive to be fair value based on our fundamentals-first approach to sovereign credit analysis. Our approach includes comprehensively assessing an issuer’s credit-risk profile and ranking the creditworthiness of countries.
We believe investors with longer-term time horizons have rarely seen such an attractive opportunity to go long on EMD. Ex-post credit losses versus what is priced in by markets today are likely to differ wildly, potentially boosting returns for the long-term investor.
We believe investors with longer-term time horizons have very rarely seen such an attractive opportunity to go long EMD.
Our proprietary quantitative model and combined top-down, bottom-up approach help us identify strong relative value ideas. We are region-agnostic and prefer to segment our investable universe into three buckets based on different risk profiles: low-beta, middle-beta, and high-beta countries. We are defensively positioned overall but have a small allocation to distressed, high-beta, high-yield countries, where the average bond price is compelling.
We see opportunities in today’s environment to add selected exposure across our buckets.
In the low-beta segment, we are trying to prioritize positions in EMs where we find fundamental strength, including faster-growing economies, ample fiscal space, and strong balance sheets; examples include Russia, Kuwait, and Hungary.
In the medium-beta segment, we are overweight on Guatemala, Qatar, and select Brazilian corporate credits, because we feel they offer strong fundamentals and decent valuations.
In the high-beta segment, we are overweight on Argentina, Ecuador, and Lebanon, which are trading at distressed levels, and Ukraine, which has strong support from the International Monetary Fund.
EMD has historically displayed very high-risk adjusted returns over the long run, given the asset class’s income potential, relatively low default risk, and relatively high post-crisis recovery values. We do not see this changing, even if we see some pickup in EMD default risk in the near term. This means we view today’s overstated spreads as an attractive entry point.
Marcelo Assalin, CFA, is a portfolio manager on and head of William Blair’s Emerging Markets Debt team.
Investing involves risks, including the possible loss of principal. Investing in foreign denominated and/or domiciled securities may involve heightened risk due to currency fluctuations, and economic and political risks. These risks may be enhanced in emerging markets. Investing in the bond market is subject to certain risks including market, interest rate, issuer, credit, and inflation risk. Rising interest rates generally cause bond prices to fall. Sovereign debt securities are subject to the risk that an entity may delay or refuse to pay interest or principal on its sovereign debt because of cash flow problems, insufficient foreign reserves, or political or other considerations. High-yield, lower-rated securities involve greater risk than higher-rated securities; portfolios that invest in them may be subject to greater levels of credit and liquidity risk than portfolios that do not. Diversification does not ensure against loss. Portfolio information is based on a representative portfolio and is subject to change without notice. Past performance is not indicative of future returns.
Beta is a quantitative measure of the volatility of a portfolio relative to the overall market, represented by a comparable benchmark. Option‐adjusted spread (OAS) is a measure of the spread of a fixed income investment’s yield relative to a benchmark, adjusted to take into account an embedded option.
The Bloomberg Barclays Global Aggregate Index is a flagship measure of global investment grade debt from twenty-four local currency markets. This multi-currency benchmark includes treasury, government-related, corporate and securitized fixed-rate bonds from both developed and emerging markets issuers. The Bloomberg Barclays US Aggregate Credit Index measures the investment grade, US dollar-denominated, fixed-rate, taxable corporate and government related bond markets. It is composed of the US Corporate Index and a non-corporate component that includes foreign agencies, sovereigns, supranationals and local authorities. The J.P. Morgan Emerging Market Bond Index Global Diversified (EMBIGD) tracks the total return of U.S.-dollar-denominated debt instruments issued by sovereign and quasi-sovereign entities.
New Zealand dollar pares losses as RBNZ pauses
RBNZ holds benchmark rate at 5.5% The New Zealand dollar has posted small losses on Wednesday. In Europe, NZD/USD is trading at 0.5901 in Europe, down…
- RBNZ holds benchmark rate at 5.5%
The New Zealand dollar has posted small losses on Wednesday. In Europe, NZD/USD is trading at 0.5901 in Europe, down 0.11%. Earlier, NZD/USD fell as much as 0.50% before paring these losses.
The New Zealand dollar is trying to find its footing in what has been a dismal week. NZD/USD is down 1.6% this week and fell to a one-month low earlier today. Still, the kiwi has shown little reaction to the Reserve Bank of New Zealand’s decision to pause rates for a third time.
The pause in rate hikes was expected and the monetary statement didn’t contain anything new. The statement said that interest rates had cooled economic activity and reduced inflation “as required”, adding that interest rates would need to remain restrictive to ensure that inflation falls back within its 1%-3% target range.
The message from the RBNZ was rather dovish and signalled that the tightening cycle is over. Policy makers don’t want to spell out that rates have peaked, as they would lose credibility if inflation moved higher and the RBNZ was forced to raise rates. The takeaway from the meeting is that the RBNZ appears content to wait for restrictive policy settings to filter through the economy and dampen inflation, which is running at a 6% clip. This stance won’t provide any relief for the struggling New Zealand dollar.
US Treasury yields continue to move higher as the selloff in global bond markets has gained momentum. This has helped boost the US dollar as more attractive yields on Treasury bonds have dampened risk appetite. The yield on 30-year Treasuries touched 5% on Tuesday, its highest level in over a decade.
The Federal Reserve has signalled that it is unlikely to lower rates anytime soon, given the strong US economy. Atlanta Fed President Raphael Bostic said on Tuesday that the Fed should hold rates at elevated levels “for a long time” in order to bring inflation back down to the 2% target. Bostic said he favoured a single rate cut in 2024, late in the year.
- NZD/USD is testing resistance at 0.5917. The next resistance line is 0.5947
- There is support at 0.5888 and 0.5833
A Promising player in the energy revolution
In recent years, the demand for sustainable energy sources has intensified, leading…
The post A Promising player in the energy revolution appeared first…
In recent years, the demand for sustainable energy sources has intensified, leading to a surge in the global lithium market.
As electric vehicles (EVs) gain popularity, lithium-ion batteries have become instrumental in meeting the growing energy storage needs. Argentina Lithium & Energy Corp. (TSXV:LIT) is a Canadian mineral exploration company with a strategic approach and a strong commitment to sustainable practices. This is one company that is well-positioned to capitalize on the rising demand for lithium.The Stellantis investmentIn a significant move that underscores the growing importance of lithium in the automotive industry, the company recently secured a substantial US$90 million investment from Stellantis. This investment not only validates Argentina Lithium’s potential but also highlights the pivotal role lithium plays in the transition to a carbon-neutral future.What makes this investment significant
Stellantis, formed through the merger of Fiat Chrysler Automobiles and Groupe PSA, is one of the world’s largest automotive manufacturers. Their decision to invest such a significant amount in Argentina Lithium & Energy potentially helps secure a future supply of lithium in a rapidly growing market. This investment will not only provide Argentina Lithium with the necessary capital to explore and advance its projects but also highlights the industry’s recognition of Argentina’s lithium potential.Expansion of lithium projectsWith the infusion of funds from Stellantis, Argentina Lithium & Energy can accelerate the advancement of its lithium projects. The company’s projects are all located in the prolific Lithium Triangle region of Argentina, which holds immense promise because of its abundant, and in many cases, high-grade lithium resources. This investment will expedite the exploration process and potentially fast track the path to future lithium project development and production.
Speaking on this investment, Argentina Lithium President and Chief Executive Officer Nikolaos Cacos said in a news release: “We are delighted to have Stellantis as a partner in the exploration and future development of our lithium projects in Argentina. Together, we share a vision to build a sustainable lithium mining operation for the future. We look forward to a strong and successful relationship with Stellantis and we are committed to working towards delivering a sustainable lithium product that will contribute to the electrification of transportation and the protection of our atmosphere.”
Meeting the rising demand for EVsAs the world shifts towards sustainable transportation alternatives, EVs are expected to dominate the automotive sector. Lithium-ion batteries are the preferred power storage component for EVs, making lithium a vital component in the energy revolution. The investment by Stellantis in Argentina Lithium & Energy Corp. can potentially help ensure a stable supply of lithium, enabling the automotive giant to meet the soaring demand for EVs while reducing their carbon footprint.Embracing sustainable practicesThe company recognizes the importance of exploration and mining operations that prioritize environmental sustainability and social responsibility. The company is committed to minimizing its ecological footprint and engaging with local communities to ensure mutual benefits..For your considerationArgentina Lithium & Energy Corp.’s partnership with Stellantis through a US$90 million investment is a testament to its potential as a key player in the global lithium market.
The company’s stock shot up 113 per cent on this news.Argentina Lithium & Energy Corp. stock chart – April to September 2023.
As the demand for lithium continues to surge, the company’s commitment to sustainable practices and strategic projects in Argentina’s lithium-rich regions position it favorably among industry leaders. With this significant investment, Argentina Lithium & Energy Corp. is working to contribute significantly to the advancement of the clean energy transition while offering an appealing investment opportunity for those looking to support the growth of sustainable technologies.
Join the discussion: Find out what everybody’s saying about this stock on the Argentina Lithium & Energy Corp. Bullboard, and check out the rest of Stockhouse’s stock forums and message boards.
This is sponsored content issued on behalf of Argentina Lithium & Energy Corp., please see full disclaimer here.canada
Strategic Ambiguity Leaves Intervention Question Unanswered, but US Dollar has Steadied
Overview: Dramatic yen price action around the JOLTS
report yesterday after the dollar pierced the JPY150 level spurred speculation
of BOJ intervention….
Overview: Dramatic yen price action around the JOLTS report yesterday after the dollar pierced the JPY150 level spurred speculation of BOJ intervention. Although there has been no confirmation, the strategic ambiguity is helping steady the yen and the dollar more broadly today, even though US yields remain firm. Final PMI readings were a better than the flash estimates and this may also be facilitating the consolidative tone. Most promising, from a technical point of view, is the recovery in sterling, which after taking out yesterday's low is now trading above yesterday's high. Among the G10, only the yen and New Zealand dollar (RBNZ held as widely expected) are slightly softer. Most emerging market currencies are also firmer, including the Polish zloty, where the central bank may cut rates later today.
Asia-Pacific equities fell sharply, with Japan and South Korea off more than 2% (which may help explain the won leading the losing emerging market currencies, off more than 1%). It is the third consecutive losing session for the MSCI Asia Pacific Index. Europe's Stoxx 600 is slightly firmer after losing more than 1% on Monday and again yesterday. US index futures are straddling little changed levels. Benchmark 10-year yields are higher. The 10-year JGB is at new highs, slightly above 0.80%, while European yields are mostly 2-3 bp higher. The 10-year US Treasury yield is pushing above 4.80%. Gold is consolidating after falling to almost $1815 yesterday, the lowest level since March. November WTI could not sustain yesterday's modest upticks and has come back heavier today. It is holding above yesterday's low near $87.75. Demand destruction concerns is offsetting OPEC+ expected confirmation of current output.
Neither Japan nor Australia's final service and composite PMIs change the fundamental picture, though they were better than the initial projections. At 53.8 rather than 53.3 flash reading (down from 54.3 in August), Japan's service PMI matches the lowest since January. The composite reading is at 52.1 rather than the preliminary estimate of 51.8 (52.6 in August). It averaged 52.3 in Q3 after 53.1 in Q2. Australia's services and composite PMI rose back above 50 in September after spending July and August below the boom/bust level. September services PMI stands at 51.8 (50.5 flash estimate and 47.8 in August). The final composite estimate was 51.5 up from preliminary estimate of 50.2 and 48.0 in August. It is the best since May. It averaged 49.2 in Q3 after 51.6 in Q2.
Japanese officials have pushed back against idea that there is an "intervention level" and instead have encouraged the market to focus on volatility. Still, despite yesterday's dramatic swing there still is not confirmation of material intervention, One-week yen vol embedded in the options market jumped to 9.4% yesterday and almost 9.8% today before pulling back to below 9%. It reached the lowest level in around 18 months last week around 6.5%. It was near 22% when the BOJ last intervened in Oct 2022. Three-month implied vol is near 9.9%. The low last week was close to 9%. The year's low was set in mid-June near 8.8%. It was closer to 13.4% in September 2022 and spiked to 14.8% October 21, 2022, when the BOJ intervened.
The dollar pushed above JPY150, where options for almost $800 mln expire today and $1.5 bln expire on Friday. After spiking to JPY150.15, the highest close from 2022, the dollar dropped to about JPY147.45 and many suspect intervention. It may not be known for sure until the end of the month report is released. Last year, the BOJ did not intervene outside of Japan's time zone. It may have checked rates, though there are no reports that it did. With US yields making new highs and the BOJ buying JGBs today, it still does not seem like an opportune time to intervene and the relatively modest vol suggests intervention would not receive much sympathy within the G7 and the EBS volume at time of the "intervention" seemed light. Still, the market has been spooked and the greenback is in a narrow range of about 30 pips on either side of JPY149.00. The Australian dollar was sold a little through $0.6290 yesterday to draw near last November's low near $0.6270. Yesterday's low is holding today, and the Aussie is hovering around $0.6325 in quiet dealings. But it is barely entering the Bollinger Band, where the lower end is found around $0.6320. A break could signal another 1% loss on the way to last October's low around $0.6170. Surprising no one, the Reserve Bank of New Zealand maintained its overnight cash rate target at 5.50% where it has been since May. The New Zealand dollar peaked at the end of last week near $0.6050, the highest since mid-August but sold off Monday and Tuesday to briefly trade below $0.5900. Follow-through selling today took it to almost $0.5870. The year's low was set in early September near $0.5860. The US dollar remains firm against the offshore yuan. It reached CNH7.33 yesterday and is holding below it today. It is trading near CNH7.3150. It was near CNH7.2950 when the mainland holiday began.
The final September EMU services PMI confirmed the first improvement since April. The pace of contraction in services slowed to 48.7 (48.4 flash estimate) from 47.9 in August. Last September it was at 48.8. The same is true of the composite PMI. It now stands at 47.2, rather than 47.1 initial estimate and 48.1 in September 2022. The new news was not so much about the minor revisions to the German (where the services PMI rose above 50 after dipping below it in August) and French flash estimate (44.1 composite from 43.5 preliminary estimate and 46.0 in August), but modest improvement in Italy (composite at 49.2 vs. 48.2) and Spain (50.1 composite, up from 48.6). Separately, the Eurostat reported that retail sales fell by a dramatic 1.2% (volume terms) in the eurozone in August, the biggest decline this year and more than twice what the median forecast in Bloomberg's survey projected.
The UK's final services PMI is at 49.3 rather than the initial estimate of 47.2 and 49.5 in August. It has not risen since April. The composite PMI stands at 48.5 (46.8 flash and 48.6 in August). It averaged 49.3 in Q3, down from a 53.9 average in Q2 and 51.3 average in Q1. The UK economy seemed to have hit an inflection point. The composite moved above the 50 boom/bust level in February and peaked at 54.9 in April and has fallen since and pushed back below 50 in August. Recall that the economy contracted by 0.5% in July, more than twice the decline expected (median forecast in Bloomberg's survey was -0.2%). August's monthly GDP estimate will be reported next week (October 12) amid renewed recession fears.
The euro found support after the US JOLTS report slightly below $1.0450. It found support slightly above it today. Since pushing below $1.05 in the US afternoon on Monday, the euro has not been able rise back above it. A move above the $1.0550 area may be needed to stabilize the tone. The $1.04 area is the next technical objective. There are options for nearly 2 bln euros that expire Friday at $1.0450. Sterling's drop yesterday to almost $1.2050 met the (38.2%) retracement objective of sterling's recovery from September 2022 record low near $1.0350 to the mid-July high around $1.3140. That retracement was $1.2075. The next important technical area is $1.20, which also corresponds to the measuring objective of the head and shoulders pattern. Sterling made a marginal new low today near $1.2035 before bouncing back and trading above yesterday's high (~$1.2100). A potential bullish key reversal is unfolding but the close is critical. To confirm the one-day reversal pattern, sterling must close above yesterday's high. Lastly, after cutting the reference rate by 75 bp last month (to 6.0%), Poland's central bank is expected to deliver another quarter-point cut today. Since last month's rate cut, the Polish zloty has been among the worst performing emerging market currencies, falling by about 3.7% against the dollar and around 1.3% against the euro.
Although many observers have downplayed the JOLTS report, its unexpected strength reported yesterday, helped lift US interest rates and the greenback. Job openings jumped by 7.7% in August, the largest increase since July 2021, to 9.61 mln. The median forecast in Bloomberg's survey was for a small decline. Moreover, the July series was revised higher (to 8.92 mln from 8.83 mln). The focus stays on the US labor market with the ADP estimate due today, Challenger lay-offs tomorrow, and the monthly payroll report on Friday. The median forecast in Bloomberg's survey has crept up to 170k (187k in August). A slowing of job growth was supported to herald the pullback in the US consumer and slow the economy in Q4. August factory orders and another look at durable goods orders are also on tap, but they will likely be overshadowed by the ISM services, which has been running stronger than the services PMI, where the final reading is also due today (50.2 vs 50.5 in August, the lowest since January.
We argued in our monthly outlook that the weak link may not be the US economy or dis-inflation but the financial sector. Remember when banks complained that the low rates squeezed interest income. Since February and March, the increase in rates has weakened bank shares. KBW's two bank share indices (one for large banks and one for regional banks) have been trending lower since late July. Yesterday, they both gapped lower. The regional bank index fell to its lowest level since late June, while the large bank index is at its lowest level since mid-May. Last week's Fed report (H.4.1) showed a small increase in both discount window borrowings ($3.193 bln vs. $3.078 bln) and the Bank Term Funding Program to a new record ($107.715 bln vs. $107.599 bln).
The US dollar's surge against the Canadian dollar extended to CAD1.3735 yesterday, which is about where the trendline off the 2020, 2022 and 2023 highs intersected yesterday. Last week's low was set before Canada's July GDP (flat vs. median forecast in Bloomberg's survey for 0.1% after -0.2% in June) and before US income, consumption and deflator was almost CAD1.3415. The greenback's surge has carried it to its highest level since March and through the upper Bollinger Band (~CAD1.3710). It is consolidating in a narrow range of about CAD1.3695-CAD1.3725 today. A close below CAD1.3660 would confirm the greenback's upside momentum has stalled. That said, the next important chart area is CAD1.3800-15 and then the year's high set on March 10 near CAD1.3860. The greenback's surge and risk-off has overwhelmed the Mexican peso too. The greenback pushed above MXN18.00 for the first time since early May and closed above the 200-day moving average (~MXN17.8245) for the first time since September 2022. Follow-through buying today lifted the US dollar a little above MXN18.2150 before the reversing lower to approached MXN18.00. A break of MXN17.80 would stabilize the technical tone. One take away is that this is not a peso move but a dollar move. For example, the peso and Brazilian real fell by roughly the same amount (-1.6%). Latam currencies, which have been the market's darlings this year, accounted for the five of the six weakest emerging market currencies yesterday, with the South African rand joining them.
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