(Bloomberg) — The craze for junk-rated debt of some of the world’s riskiest countries has sent an emerging-market risk premium to the lowest level since before the Covid shock five years ago.
The additional yield investors demand to own EM sovereign dollar bonds over US Treasuries narrowed to 314 basis points, data from JPMorgan Chase & Co. show. That’s the tightest spread since February 2020, a month before a surge in Covid-19 cases caused a global selloff and a bout of debt defaults.
While the risk premium covers both investment-grade and high-yield securities, its recent drop stems primarily from the latter as investors are looking to benefit from debt restructurings and fiscal reforms. They’re also looking for assets with shorter durations that are less exposed to swings in Treasuries. Emerging-market junk bonds satisfy both requirements.
“Sovereign high-yield has been a big factor in the spread compression,” said Anders Faergemann, co-head of EM global fixed income at Pinebridge Investments in London. “Within that universe, the debt restructuring names have provided the bulk of returns.”
The sovereign risk premium for emerging market issuers has narrowed 116 basis points since Aug. 5 as high-yield bonds gained amid investor expectations for Federal Reserve easing and several sovereign borrowers returned to the primary market.
During this period, Lebanese bonds alone have generated total returns of 156%, as investors’ bets paid off and the country’s leaders overcame their disputes and formed a functional government. A reform-friendly cabinet has boosted optimism that the process will eventually result in a debt restructuring.
Argentina, benefiting from President Javier Milei’s fiscal makeover, has handed bondholders returns of 64% over this period. Hopes for an end to the war in Ukraine have spurred a 39% return, while money managers have made more than 30% each in Ecuador, El Salvador and Sri Lanka, all touting country-specific turnaround themes.
“EM fundamentals have improved, the Fed has lowered interest rates, and most EM sovereign high-yield names have market access,” Faergemann said. That provides “a platform for EM HY to perform well as long as US HY spreads remain tight.”
Meanwhile, EM investment-grade bonds have struggled to keep up. While they outperformed US Treasuries in August, they have lost steam since then. Their spread over the risk-free rate has widened 15 basis points in the past three months to 121.
All this left EM high-yield bonds yielding just 411 basis points in additional return over their investment-grade counterparts last week. That’s less than half of the 890 basis points of additional compensation they offered at the height of the EM debt crisis in 2022.
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