It seems that the never-ending “thirst for yield” from the world’s massive pension funds, combined with the ever-present “cash on the sidelines” problem, is driving the creation of yet another global financial bubble in emerging market junk bonds. Alas, as the FT points out today, the world’s largest fixed income investors can’t seem to get enough of the risky paper as bond issuance by the most financially vulnerable countries has suddenly spiked to a all-time high of $75 billion just as spreads are tightening to all-time lows.
Junk-rated emerging market sovereigns have raised $75bn in syndicated bonds so far this year, up 50 per cent year on year to the highest total on record, according to figures from Dealogic, a data provider.
The increase has buoyed the total volume of debt-raising by developing economies; non-investment grade issuance has made up 40 per cent of the new debt syndicated in EM so far in 2017.
These rare and new issuers have been lured into the market by attractive pricing — strong investor demand for EM debt has pushed pricing up and yields down, making it one of the best-performing assets globally in 2017.
According to Bloomberg Barclays indices, EM’s local currency-denominated sovereign debt has returned 10.4 per cent since the start of this year, while dollar-denominated debt has returned 7.6 per cent. By contrast, US Treasuries have returned 2.5 per cent while European nations’ debt has returned 0.9 per cent.
Of course, for all the “doom and gloom” predictions of an imminent crash in Emerging Markets (here and here, among many others), not only have these not materialized, but the average yield on corporate junk bonds issued by emerging markets has dropped to record-low levels of around 5.5%, compared to nearly 10% just 2 years ago.
For a case study of the yield-chasing insanity unleashed by central bankers, one has to look no further than Tajikistan.
The central Asian country last month raised $500 million in its first-ever international bond sale, paying just 7.125% in annual interest on the debt after the U.S.-dollar offering drew a swarm of American and European buyers. Bankers had earlier shopped the 10-year bonds from the former Soviet satellite with an 8% yield, which was pulled down by strong investor demand.
The reason for the scramble into any piece of yielding debt, even Tajik junk bonds is simple: as the IMF shows today in its latest financial stability report, there are virtually no IG bonds left with yields above 4%, and in the junk bonds space, whether in the US or offshore, it isn’t much better.
Meanwhile, as the head of EM asset allocation at UBS Wealth Management, Michael Bollinger, pointed out to the FT, holding the 7.125% Tajik bonds until maturity can be a great yield for a pension fund with a 7% return target…that is, until the bonds can’t be refinanced at maturity.
Michael Bollinger, head of EM asset allocation at UBS Wealth Management, said that relatively high-risk, high-yield sovereigns were attractive to institutional investors and private clients to hold to maturity.
“The problem with liquidity is that when you need it most, it is least available, and that problem can be particularly pronounced in these rare issuer names,” he said.
Will the flurry of issuance continue? Mr Bollinger expects it to ease off. “Some of these guys will start to find it more difficult — at this point in the cycle it is time to become more selective in EM bonds,” he said.
Meanwhile, Mr Rediker warns that sovereigns with poor credit ratings could struggle to refinance their debt when it matures.
“What if the rollover risk is greater than investors and issuers think it is?” he said. “That is a premise that not everybody seems to be taking as seriously as they might.”
Of course, with garbage bonds (it’s a technical term) in Illinois yielding 3.74% (see: Muni Investors Celebrate “Juicy” 3.74% Yield On New Illinois Bonds As State Hurdles Toward Bankruptcy), it’s not all that difficult to understand why bond investors see relative value in Tajikistan.