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Emerging Bonds May End Best Rally Since 2002 as Yields Plunge
Bloomberg
July 01, 2009

By Laura Cochrane

July 1 (Bloomberg) -- The biggest gains for emerging-market bonds since 2002 cut yields so fast that debt from the Ukraine to Ecuador appears expensive, say Commerzbank AG, Aviva Investors Ltd. and RBC Capital Markets.

Developing-nation bonds returned 10.2 percent in the second quarter, the most in seven years, and 13.8 percent for the first half, indexes compiled by Merrill Lynch & Co. show. Investors snapped up the debt on prospects government stimulus plans, interest-rate cuts and the promise of as much as $750 billion of International Monetary Fund support would help struggling nations overcome the worldwide recession.

The rally caused the yield spread on emerging-market bonds over U.S. Treasuries to narrow 2.45 percentage points since Dec. 31 to a spread of 4.45 percentage points, the biggest contraction since 2003, according to JPMorgan Chase & Co. The spread narrowed to 4.23 points as of 1 p.m. in Singapore. The gap on Ukrainian debt shrank by more than half between March 10 and May 28, while Ecuador's bond spread collapsed 20.37 percentage points.

"I don't think bonds look cheap anymore and I don't see another catalyst for a bond rally," said Kieran Curtis, who helps manage $800 million in emerging-market debt at Aviva Investors in London, a unit of the U.K.'s largest insurer. He said he's been buying debt from Qatar and South Korea and selling Mexican bonds.

The rally faltered last week after the World Bank revised its 2009 global economic contraction forecast to 2.9 percent from 1.7 percent, undermining demand for developing nations' commodity exports.

'V-Shaped Recovery'

"It's hard to get excited about a V-shaped recovery," said Siobhan Morden, a Latin America debt strategist at RBS Securities Inc. in New York. Emerging-market bonds are "probably going to be range-bound" near current levels, she said.

A deepening economic slump in Russia and speculation of a currency devaluation in Latvia also added to signs the recovery may still be months away.

Russia's gross domestic product will tumble 7.5 percent this year, sending "damaging waves" throughout the former Soviet Union, the World Bank said. Latvia's economy will shrink 16 percent in 2009 and unemployment will surpass 20 percent, fueling devaluation concerns, according to Standard & Poor's. S&P put Latvia's BB+ foreign debt rating on CreditWatch with negative implications on June 8.

Pakistan, Ukraine

Bonds issued by Pakistan and Ukraine led the first-half rally as default concerns eased after the countries secured IMF financing.

Pakistan's dollar-denominated bonds returned 94 percent as their yield spread over U.S. Treasuries fell to 10.39 percentage points from 21.12 percentage points, according to JPMorgan Chase data. Ukraine's bonds gained 89 percent. Their yield spread dropped to 11.68 percentage points yesterday from a record 35.93 percentage points on March 10. The rally is the biggest since JPMorgan began tracking Ukrainian dollar debt in 2001.

"The magnitude of the spread compression has been a major surprise," said Luis Costa, an emerging-market debt strategist at Commerzbank in London. He said he expects the rally to end this quarter as a slower global recovery undermines growth in developing nations.

Argentine and Ecuadorean bonds also returned more than 60 percent. The yield gap on Ecuador's bonds collapsed to 26.94 percentage points from 47.31 percentage points after the South American country bought back 91 percent of the $3.2 billion of debt it defaulted on in December and in March.

Argentina's bond spread shrank 6.58 percentage points to 10.46 percentage points on speculation the government will be able to meet debt payments this year and next.

No Relapse

While the rally may be over, Morden said few investors expect bonds to tumble again. Argentine and Venezuelan bonds, among the highest-yielding securities in emerging markets, may extend gains, she said.

"No one is positioned for a selloff," Morden said. "I'm not expecting a relapse to the global credit crisis.

Developing-nation borrowers stepped up bond sales to take advantage of the rally after the collapse of Lehman Brothers Holdings Inc. in September shut them out of the market for most of the fourth quarter.

Sales Pickup

Emerging-market countries and companies sold more than $77 billion of international bonds in the first half, the most in two years, according to data compiled by Bloomberg. Colombia raised $2 billion, Abu Dhabi sold $3 billion and Russia's OAO Gazprom issued $2.25 billion.

Debt sales will reach $115 billion by yearend as governments boost borrowing to fund stimulus plans and cover budget gaps, said Nick Chamie, head of emerging-market research at RBC Capital Markets in Toronto.

Issuance will "be strong" if borrowing costs drop again following an increase over the past three weeks, Chamie said. Developing-nation yield spreads climbed 37 basis points from a nine-month low of 4.08 percentage points on June 10.

Spreads may rise to between 5.75 percentage points and 6 percentage points in the second half, Chamie said.

"The extent to which spreads collapsed this year surprised me," Chamie said.

To contact the reporter on this story: Laura Cochrane in London at lcochrane3@bloomberg.net

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