December’s annual meeting of EMTA was not quite as depressing as many might have expected, especially given that it was held in the middle of a New York snowstorm.
Since the previous meeting of the group, formerly known as the Emerging Markets Traders Association, Argentina had defaulted and Brazil had traded to distressed levels. A couple of years ago, these two countries alone accounted for 48% of JPMorgan’s benchmark Embi index; now, they are trading at 6,200 basis points and 1,600bp over US treasuries respectively.
Even so, the Embi managed to round out 2002 with a positive total return: it ended the year up 11% or so, thanks to fudging and luck. The fudging came with the 2001 megaswap of Argentine debt, lead managed by JPMorgan, which reduced Argentina’s bonds to 3% of the total index. The luck came with the downward grind in US treasury yields, giving significant price gains on bonds trading at unchanging spreads.
So though Latin America has historically comprised the vast majority of emerging market sovereign debt, the past year has seen a large reweighting.
For one thing, it’s much oilier. Mexico and Russia – major oil exporters – now account for 43% of the Embi. Argentina and Brazil, on the other hand, are net oil importers.
And the Embi is now more diverse than ever: spreads range all over the place, from under 50bp for Hungary to over 2,000bp for Nigeria. The Latin Embi stands at more than 1,000bp over, the European Embi is under 450bp and the Asian Embi under 300bp.
“Credit spreads in eastern Europe and Asia are pathetically absurd,” says Hari Hariharan, portfolio manager at New World Investments. “What are we doing lending at wafer-thin spreads on top of a US treasury curve which is nominally extremely low?”
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EMBI Indices (Jan-12 Dec 02) |
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| Source: JPMorgan EMBI Indices |
Two convergence plays
But the fact is that Europe and Asia are both essentially convergence plays: the former on the EU, and the latter on China. The economic superpowers in each region are acting as a magnet for sovereign spreads in a way that the US only manages to do for Mexico. South America and Africa, it seems, are going to be left to their own devices, bereft of political or economic sponsorship.
This means that as far as the benchmark Embi is concerned, its performance in 2003 comes down to two variables: treasury bond yields and Brazil. Since spreads in Europe and Asia will stay tight, returns there are going to be based on the performance of the underlying treasuries, just as in 2002. And Brazil’s bond spreads are unsustainable at current levels: either there’s a confidence boost and they come in sharply and quickly, or Brazil aproaches default and they balloon.
Other concerns, such as whether Russia can keep moving towards investment grade, or whether the US invades Iraq, are ultimately secondary. And the topic that seems foremost for policymakers and industry groups – whether to implement a contractual or a statutory approach to sovereign debt restructuring – is almost irrelevant.
The keynote speaker at the EMTA meeting was John Taylor, undersecretary for international affairs at the US Treasury. He spoke on collective action clauses and said little that was new, surprising, or even very interesting.
A lost opportunity The audience mostly tried to keep questions on the subject at hand, but one trader didn’t want to let an opportunity pass.
He was a Republican, he said, and a staunch supporter of the Bush administration’s foreign policy, but he felt that with all the emphasis on terror and Iraq, the US was losing its chance to provide security, opportunity and prosperity in its own hemisphere. Earlier on in the proceedings, José-Luis Daza, head of emerging markets research at Deutsche Bank, had said: “This is the most protectionist administration in a generation,” and so far, for every trade pact with Chile there’s been a hike in steel tariffs.
Taylor responded by saying that the administration was working on negotiating a Free Trade Agreement of the Americas: he was clear that beyond necessarily slow-moving trade negotiations, the US was not going to provide large-scale economic support in Latin America. The new-look Embi could be here to stay: Europe, Asia and maybe Mexico on a path to integration and long-term growth; Latin America and Africa crumbling under the weight of huge debts and unsustainable spreads.
