Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
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Turkey could prove a catalyst for a broader emerging-markets crash
Althea Spinozzi
Head of Fixed Income Strategy
Summary: Macroeconomic deterioration, higher debt burden and the coronavirus pandemic make the emerging markets prone to further downgrades and a widespread selloff. Near-zero interest rates are adding risk to the table rather than making EM debt sustainable, pushing EM sovereigns into a debt trap.
Moody’s has downgraded Turkey to B2 from B1 placing it in the club with Egypt, Rwanda and Jamaica. The rating agency has highlighted that such decision was taken over the country's fiscal buffer deterioration, growing dollarization and a substantial decrease of foreign exchange reserve. Moody's has highlighted that net reserves are close to zero if foreign-exchange liabilities and lenders' required reserves for lira are netted out. This means that Turkey remains without any room of manoeuvre in case of increased market volatility which may lead to a balance of payments crisis.
The Turkish lira and credit default swaps have been the worst performers in the Emerging Market world this quarter. At the same time, even though Turkey's government dollar bonds have been volatile throughout the year, they have provided a positive total return since the beginning of the year until today. However, they have under-performed the average emerging-market sovereign total return (please refer to the image below).
We believe that Turkey can be a catalyst for a selloff in the emerging markets space, which ultimately can leak to the corporate higher-yielding space as well as the equity space. The logic behind it it's relatively straightforward. When looking at Turkey, we see an evident deterioration of economic data which can translate to possible defaults. Suppose a bondholder is not comfortable with Turkey due to solvency reason. Why would one hold other emerging-markets sovereigns which are equally economically weak and are at the forefront of coronavirus pandemic? I am thinking about Brazil and India, but many more can be added to that list.
In light of COVID-19, the same can be said about corporates. How long can a junk bond sustain extended periods of low revenues amid partial economic lockdown?
One could argue that the market is hungry for yield, and with close to zero interest rates, debt has become more sustainable. True, interest rates are near-zero, and this is why corporates and government globally have been piling on more debt, adding more steam to an already explosive cocktail. The market will soon ask for more yield as soon as it figures it out. At that point, we will see situations like the one in the Philippines this morning where the country had to reject all bids at a 364-day T-Bill auction because of a sudden increase in demand for yield. At that point, it will be too late for borrowers because they will already be in a debt trap.
Risk in the emerging markets can be pandemic for real.
How can I trade Emerging market risk in the Saxo Platform?
There are several funds in the Saxo Platform that offer exposure to Emerging markets:
- iShares MSCI Emerging Markets UCITS ETF and CFD (IE00B0M63177) which is available in USD, EUR and GBp.
- Vanguard Emerging Markets ETF and CFD (US9220428588)
- Lyxor MSCI Emerging Markets UCITS ETF and CFD available in EUR (FR0010429068) and in GBP (FR0010435297)
If you are looking to take exposure to Turkey:
- USDTRY: if you are looking to trade the Turkish lira, but you have to be aware that market liquidity is not great
- Ishares MSCI Turkey ETF available as a CFD too (IE00B1FZS574)
- Lyxor UCITS Turkey ETF and CFD (LU1900067601)
We also have various maturities dollar Turkish cash bonds available in the platform
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