Morgan Stanley Adopts Bearish Stance on Emerging Market Bonds Amid Fed Uncertainty
1min read Morgan Stanley has adopted a cautious stance on emerging market sovereign bonds, suggesting that the Federal Reserve's expected interest rate cuts are unlikely to stimulate significant capital inflows into bond funds. Strategists, including Simon Waever, recommend that investors take a bearish short-term view on this asset class. They propose increasing cash holdings in their portfolios, favoring investment-grade notes over riskier bonds, or selling the emerging market credit default swap index.
According to a report released on Monday, the bank removed bonds from Nigeria, Argentina, and Morocco from its preferred bond basket and added bonds from Mexico and Romania, which have become "cheaper." Their outlook is partly influenced by the fact that the U.S. interest rate market pricing already reflects an expected soft landing for the U.S. economy.
The strategists stated, "Any further decline in U.S. Treasury yields could pose downside risks. It could take up to 12 months after the first rate cut for funds to shift from money market funds to risk assets."
Besides the arguments related to the Federal Reserve, the team noted that the valuations of spread in developing economies are "far from cheap," fiscal accounts have "almost universally deteriorated," and economic growth continues to slow.
They recommend that investors sell the emerging market credit default swap index, targeting a spread of 190 basis points, with a stop-loss level at 155 basis points. The spread currently stands at 167 basis points.
It is worth mentioning that developing countries have recently ramped up their defenses against volatility and embarked on a bond issuance spree. In the first five days of September alone, they issued more bonds compared to the same period in previous years. Data compiled shows that as of last Friday, emerging market governments and companies issued bonds totaling $28 billion, significantly higher than $12 billion during the same period last year.
Many issuers are aiming to complete their bond issuances before the U.S. presidential elections in November and before another growth scare similar to that of August 5. Alexander Karolev, head of the CEEMEA bond syndicate team at J.P. Morgan, remarked, "Most issuers are looking to enter the market ahead of potential volatility. Issuances are expected to drop significantly in the coming weeks due to risk events."