July was unseasonably busy for bond issuance in emerging markets. Borrowers rushed in before the summer break. Even Ukraine managed to issue a $2 billion five-year bond, after some 10 months of trying.
The Ukraine bond was priced to yield 9.25%, compared with 6.25% on the sovereign’s 2016s in June last year. But compared with a few weeks ago, the deal at least showed that a wide variety of issuers were able to access the market.
Ukraine was able to issue despite the absence of a hoped-for IMF deal or new pricing agreement with Russia on gas imports. Yet, as Commerzbank points out, this is a liquidity-driven rally in emerging market fixed income.
Flows into emerging market bond funds reached levels not seen since March at the end of July. Monetary policy in developed markets means that even investors not usually focused on emerging markets are looking for yield. And last month, the dearth of other safe-haven assets enabled Germany to issue a two-year note with a negative yield of six basis points.
But fundamental drivers in emerging markets – the formerly breakneck levels of economic growth – are increasingly less cheery: from India to China, and from Brazil to Indonesia.
As a result, a lowering of expectations of corporate earnings has driven outflows from emerging market equity funds, even as bond funds have attracted increasing inflows.
Deteriorating growth prospects have furthermore already had a dramatic turnaround effect on central bank policy in emerging markets. The South African Reserve Bank, for example, surprised markets with an earlier-than-expected 50bp cut in interest rates last month. That raised questions about whether more surprise rate cuts are to be expected, perhaps in India or Brazil.
The one important exception is Russia. Although Russia is more vulnerable to the oil price than ever, unemployment there has fallen to all-time lows and there are concerns that the economy is overheating. Some analysts still expect rate rises before the end of the year.
As Goldman Sachs research explains, this is partly because the post-2008 recovery took longer in Russia than in other emerging markets thanks to constraints in the banking sector. Also, the Russian elections in late 2011 and early 2012 meant fiscal policy was out of sync with other emerging markets.
Elsewhere in emerging markets, growth prospects and central bank moves are lowering expectations of appreciation in local currencies. Consequently, inflows to local-currency emerging market bond funds have failed to keep pace with inflows to hard-currency equivalents.
It is not much of a summer of love in emerging markets.