Milestones and pivotal turning points are easy to spot – at least in retrospect. Last month, a little-publicized event took place in the emerging markets that few participants ever dreamed possible. For the first time, the JPMorgan EMBI Plus index traded at a spread to duration-matched US treasuries that was below 200 basis points.
Never – not since the EMBI was created in the 1990s, not since the term “emerging markets” entered the financial lexicon in the 1980s, nor even since the birth of floating global rates in 1944 at the Bretton Woods conference – has risky debt been priced so high and paid so little. As recently as last June, when the EMBI spread dipped below 300bp, the market watched in jubilation for those on the long side, panic for those on the short side, or simple astonishment for those temporarily on the sidelines.
So what, if anything, does this supposed milestone mean? That depends on which side of the deal you are on. For the sell side, more often than not selling long-only trades, the EMBI’s gymnastic dip below 200bp legitimizes a mantra of upward emerging market credit rating migrations, external fiscal accounts overflowing with dollars, and commodity revenues soaring sky-high. The buy side, more than anything else, is relieved. In the global hunt for yield pick-up, ordinarily risk-averse investors have been pouring into the same handful of crowded trades, desperately betting that some far-off finance minister will manage to make the next coupon payment or at least negotiate the next refinancing with a deal-hungry banker.
As far as the future is concerned, the much more important question for everyone at the table is how to make a buck in a business with anorexic bid-ask margins and expected returns that are only a fistful of basis points higher than the guaranteed interest on a government-backed retail savings product, such as a certificate of deposit.
Perhaps focus should be directed on the disappearance of the concept of risk pricing. The orthodox view that an investor can take a decomposition of spread, then strip out and price credit risk, has been effectively tossed into the dustbin of emerging markets history. There is just way too much liquidity in the world chasing way too few interest-bearing instruments and sweeping all notion of risk pricing right off the table.
The milestone of the EMBI dipping below 200bp might not be remembered as fondly as an event such as Roger Bannister breaking the four-minute barrier for the mile but, perhaps more ominously, as comparable to the point when Nasdaq broke the 5,000 barrier in March 2000.
