Outlook 2014: Taper talk still at forefront; spreads to tighten; frontier markets to stand out

By Christine Van Dusen

Atlanta, Dec. 31 - Taper - not the kind of tall, white candle you'd have on your tabletop, but the verb to suggest cutting back - was the buzzword for emerging markets bonds in 2013, and it is expected to remain a key focus for the secondary market in 2014.

"That's been the primary driver for what's happened this year," a London-based trader said. "And it will be going into the first quarter of the next year."

For much of 2013, investors ping-ponged between feeling concerned and being bored by the talk of tapering. One minute they were atwitter at the prospect of the Federal Reserve cutting back on the bond-buying program that was intended to prop up the U.S. economy. The next minute they were lapping up the news that quantitative easing would continue. And the next minute, market-watchers were shrugging off the Fed's decision to begin tapering.

"The reduction of asset purchases by the Fed is seen as the most relevant factor setting the trend for [EM] bond yields next year," according to a report from Erste Group Research. "We expect a slowdown of asset purchases by March next year, at the latest, which has already been fairly priced into CEE bonds."

"Everything was going along quite swimmingly until March or early April, and then all hell broke loose," the London trader said. "Like the Greece situation in past years, there was a moment there were everyone hung on whatever the news flow was out of Greece, but then they got desensitized to it. People got more and more used to the fact that tapering will happen."

All of this occurred against the backdrop of weaker performance for the asset class in 2013. It was the first year since 2008 that all three JPMorgan EM fixed-income benchmarks ended in negative territory, JPMorgan said in a report.

Also contributing to the larger, mostly negative picture in 2013 was the default of Brazil's OGX Petroleo e Gas Participacoes SA and pressure on the Asian coal industry.

Corporate spreads to tighten

Looking to the corporate sector in 2014, it's expected that interest rates will drive performance and that spreads will tighten by 33 bps to 320 bps, with a narrowing to 210 bps for investment-grade and 610 bps for high yield, according to a report from BofA Merrill Lynch.

This would result in a flat return for EM corporates, overall, in 2014.

Sovereigns should see a 25 bps compression of spread, the report said.

"In 2014, we believe country selection is critical, as corporate spreads are still most highly correlated with sovereign performance," the report said. "This lesson was demonstrated in 2013 as some of the weakest performing corporates were located in countries with volatile sovereign performance."

The macro environment, interest rates, bank lending conditions, issuer fundamentals, default rates and the positioning related to the curve, quality and the region will drive corporate performance in 2014, the report said.

LatAm may outperform

Latin American corporate bonds are expected to outperform those from emerging Europe and Asia in the new year, the BofA Merrill Lynch report said.

"LatAm corporates have underperformed the rest of EM to a large extent across all rating categories since 2012," the report said. "We believe they are positioned to rebound in 2014."

Meanwhile, on the corporate side, Brazil may struggle in 2014, given that the sovereign has seen "luster and shine come off," the London trader said.

"People are talking about Brazil downgrades," he said. "It's a commodity-based economy, and commodities have not done that well."

Yields mixed for Europe

At the same time, the potential for gains in emerging Europe and Asia is limited, given the tight spreads and potentially tougher benchmark yield comparison, BofA Merrill Lynch said.

Croatia is likely to see yield increases as tight liquidity management puts pressure on the currency, according to a report from Erste Group Research.

And the Czech Republic's yields should stay low as the sovereign continues to have abundant liquidity and lower gross supply. And issuance should be slow from Slovakia in 2014, due to buybacks, Erste said.

Dubai a solid bet

Looking at the Middle East - which saw the most trading activity for Abu Dhabi Islamic Bank's perpetual notes and Abu Dhabi Commercial Bank's 2023 notes in 2013 - investing in Dubai corporates could be compelling in 2014, JPMorgan said.

"Anything long-dated, fixed-income, low-beta has been really crushed," the London trader said.

For example, Qatar's 2042s started 2013 yielding 4% and are now closing out at about 5.4%.

"That doesn't sound like much, but the longer the duration, the more the sensitivity to a basis point change," he said.

Front-dated bonds held in much better, he said.

Investors eye Turkey

From a geographic perspective, Turkey took a beating in 2013, as did bonds from South Africa and Indonesia, a trader said.

"They sold off quite heavily," he said. "We saw that in the latter half of the year. It has since come back, primarily because they're oversold. Those countries are running current account deficits and rely on foreign capital. So that's something to watch for in 2014."

Investors also should keep an eye on Turkish banks, a trader said.

"The increased borrowing really exploded in the last couple of years," he said. "You used to be able to count on one hand the number of bonds, outside the sovereign, in Turkey. It can now be a dedicated trade, with 25 or 30 bonds to trade."

Stick with frontier bonds

Market-watchers are recommending that EM bond investors hold on to their overweight positions in Angola, the Ivory Coast, the Dominican Republic and Morocco.

"We favor EM high-yield corporates over investment-grade and prefer Asian credits over Latin America," JPMorgan said in its report. "Value is also compelling for select short-dated Russia BB corporates."

It's also suggested the investors favor hard-currency debt over local-currency deals.

And all the while, investors should keep the word "taper" in the backs of their minds, the London trader said.

"It's all about the Fed," a trader said. "Deals can get done, people get used to spreads and more and more yields are higher than they were. It's now normalizing. It's not going to be plain sailing. It's still a very interesting asset class, though some days I wonder why I bother. But it keeps us off the streets."

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.