A new paradigm or a bubble set to burst?
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A new paradigm or a bubble set to burst?

Improved fundamentals have undoubtedly fuelled the emerging-market debt boom. But that's by no means the whole story. Excess liquidity might be forcing values unjustifiably high, and hedge fund and credit derivative strategies are vulnerable to an overdue yield-curve readjustment.

DESPITE COUNTLESS PREMATURE rumours of a collapse, global emerging markets remain hot. The benchmark indicator for the asset class, the JPMorgan Emerging Bond Market Index (Embi), has been hovering near an all-time high. The Brazilian C bond, which was until recently one of the most liquid emerging-market instruments, has rallied strongly to well above 100 – even though the bond is callable at par, domestic Brazilian investors are skittish about the economy, and the government is now the subject of one of the worst corruption scandals of the decade. 

In Argentina, despite the disapproval of fund managers around the globe, a highly successful debt exchange was completed in June and the sovereign bounced back with a sharp rally in prices on the new instruments as well as a brand new credit rating of B3 for long-term foreign currency obligations from Moody's, after years of stagnating in full default status. 

Nevertheless, in the June edition of its Sovereign Review, Fitch Ratings reported that "continuing imbalances within and between the world's largest economies are increasing the risk of a sharper downturn in global growth and a potentially destabilizing correction in asset prices. Any marked change for the worse in the global economic environment would quickly hurt emerging-markets assets." 

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