Argentina delivers another blow to emerging market debt bianco research gas nozzle prank


Emerging market bond funds suffered the first two-week spell of outflows since 2016, as a stronger US dollar raised fears about companies’ ability to repay dollar-denominated debt. Investors withdrew almost $1bn from global emerging market bond funds for the week ending May 2, according to data from EPFR Global, the largest outflow since February’s market turmoil and the first time the asset class has suffered two consecutive weekly outflows in 16 months. The data underscores the widening fallout from the rise in the dollar. The US currency has risen 2.7 per cent since the start of April against its developed market peers, while JPMorgan’s EM currency gauge is down by 4.2 per cent against the greenback. A stronger dollar raises costs for emerging market companies servicing dollar-denominated debt.

Investors yanked more than a net $1 billion from emerging-market bond funds that invest in debt denominated in hard currencies, such as the U.S. dollar and euro, in the week through Wednesday, according to EPFR Global. It meant investors have made net withdrawals from emerging-market bond funds in consecutive weeks for the first time in more than 15 months. Investors are also souring on Europe, with a net $300 million pulled out of European bond funds last week, the second straight week of outflows. Investors appear to be plowing much of this money into U.S. debt. Exchange-traded funds that buy U.S. Treasurys attracted more than a net $6 billion in April, the biggest monthly influx since January 2016, according to TrimTabs Investment Research, EPFR’s sister company.

despite a dramatic rate hike, indicating investors are jittery about a market-friendly transition in Argentina that has advanced in fits and starts. In early afternoon trade, the currency had fallen 2.53 percent to 21.75 pesos to the dollar, even as the bank hiked the benchmark interest rate 300 basis points to 33.25 percent, its second surprise hike in less than a week. Traders said investors remained nervous about the direction of Argentina as a whole, as the prospects of reducing utility subsidies grow politically more difficult and a new tax regime that went into effect last month made many investments less attractive for foreigners.

The situation in Argentina is just the latest in a series of blows for Latin American emerging markets. This compounds worries about Venezuela and trade tensions with the U.S. Growth remains supportive and ETF flows have stabilized. Bright spots remain, however, and there may still be enough fuel for some of Latin America to outperform.

Distress in Argentina is adding to worries from trade tensions are sending emerging market debt into a tailspin. Latin American sovereigns are now the worst performing members of the Bloomberg Barclays Emerging Market Aggregate US Dollar index. The map below shows the average year-to-date return on sovereign debt by emerging market nations with at least $10 billion in total debt outstanding and excluding Venezuela. Mark size reflects total debt outstanding. Argentina comprises a larger share of the index. Ecuador (-10.6%) and Argentina (-7.5%) are at the bottom of the barrel.

The next chart shows average year-to-date total returns on the left with Latin American nations highlighted. The scatter plot on the right shows 2018 total return by duration for each issue in the index. Argentina and Ecuador, both in darker shades of orange, account for the steepest losses, even at short durations. Other Latin American nations, highlighted in shades of orange, have managed to sidestep their neighbors’ troubles. Brazil and Costa Rica account for some of the best performers in the index.

The question is whether the worst is over for Latin American emerging markets. We discussed in a recent carry trade post how the economic growth backdrop in Latin America may be more favorable. The charts below show Citigroup’s economic data change indices for emerging markets in Latin America and Southeast Asia. Importantly, this does not include Argentina which makes Latin American performance look better than it otherwise would. But excluding Argentina, Latin America is looking more resilient and still above its one-year average.

We pointed out on April 26 that emerging market ETF investors were holding the line despite 10-year Treasury yields rising above 3% briefly. There are still no signs of panic. The chart below shows that although emerging market debt ETF performance has continued to slide, net flows have stabilized over the past week. On average, emerging market debt ETFs are -2% since the beginning of April, their worst performance since the post-election collapse. Yet the reaction in ETF flows has been minimal.

Recent distress in Argentina is adding to existing concerns about the collapse in Venezuela and rising trade tensions with the U.S. This has been a recipe for underperformance, with Argentina and Ecuador now the worst performers in the Bloomberg Barclays Emerging Market US Dollar index. The growth backdrop for other Latin American nations still looks supportive and investors appear to be keeping the faith. There may be a buying opportunity for some of the stronger Latin American sovereigns if they can disentangle themselves from their neighbors.