Risks Spreads To Emerging Markets

Emerging-market sovereign credit spreads came under extreme pressure Wednesday as a sell off in global stock markets intensified due to growing fears of recession.

The spread on J.P. Morgan’s emerging-market bond index, the EMBI+, broke through 700 basis points for the first time since March 2003 and is currently trading at 713 basis points over Treasurys. That’s up a hefty 33 basis points on the day and a massive 84 basis points from Friday’s close of 629 basis points.

“Another day of rising risk aversion that has seen emerging markets come under heavy selling pressure,” said analysts at RBC Capital Markets in a note to clients.

In sovereign credit-derivative markets, Russia and Turkey were among the worst hit, with their credit default swap spreads, a key measure of credit risk, widening significantly, a move that suggests investor sentiment toward them has deteriorated.

Five-year CDS on Russia widened around 64 basis points to 811/831 basis points. The price means it now costs $821,000 a year to insure a notional $10 million of Russian bonds against default for five years, up from $757,000 Tuesday and $517,000 a year ago.

Turkey’s five-year CDS widened to 684 basis points, compared with Tuesday’s close of 624 basis points given by Markit.

Comments: Risks have now spread to emerging markets. Russia and Turkey are first to get whacked. Safe to say that these developments would continue to override sentiment in all emerging markets. While we can argue that countries with healthier balance sheets such as Malaysia, Singapore, Taiwan and the like may be shielded somewhat, the overriding sentiment will tend to ignore such facts. Those with iffy balance sheet will be hurt most. The massive volatility in currency markets will bring forth a few major company "failures" such as Citic Pacific's huge currency linked losses. When currency moved as it did over the last two weeks, we are bound to see massive losses incurred by certain companies, hence brace yourselves for some major bad news affecting sentiment further. On the companies front, the markets will downgrade companies that rely on debt a lot to fund their acquisitions (such as KNM) as rolling over their loans might present a problem. Stay away from companies that are highly geared if you must hold stocks.

p/s photos: Go So Young