Bond market conditions are deteriorating

After adverse US inflation data, financial markets are now described as discounting a full one percentage point US policy rate increase at the next FOMC meeting (although S&P Global continues to assign higher probability to a 75 basis point increase). High inflation elsewhere is similarly encouraging market expectations of faster and larger rate increases in other major economies, in turn pushing central banks elsewhere to raise rates to avoid capital outflow and currency weakness.

Multiple indicators showing market deterioration

According to a Financial Times report on 10 July using JPMorgan calculations and EPFR data, investors have withdrawn around USD50 billion from Emerging Market bond funds in 2022, reversing the full year inflow in 2021. The data shown shows that this performance is the worst in 17 years. The same report notes that the benchmark index for EM dollar sovereign bonds, the JPMorgan EMBI Global Diversified Index, had fallen 18.6 per cent in 2022, its worst performance since 1994.

SIFMA data for the first half of 2022 (year to date) recorded a 29.3% decline year-on-year in total issuance of debt securities within the US markets. The sharpest declines were in mortgage related and asset backed securities, which declined by 46% and 41.3%, while corporate debt sales fell from USD1139.4 billion in H1 2021 to USD839.6 billion, a 26.3% decline.

A Financial Times article on 2 July using Ice Data claimed that the volume of European corporate bonds showing debt distress - defined by a yield of ten percentage points over government benchmarks - had risen from 1.3% of the components of the ICE index of sub-investment grade European bonds at end 2021 to 8.8% of the index at end-June. In volume terms, the distressed population has risen from EUR6 billion at end-2021 to EUR40 billion. The report aligned with concerns raised by S&P Global which recently warned of the "increasingly murky outlook" for European corporate credit quality.

There are some positive developments in emerging markets

Oman announced on 8 July that it will repay OMR512 million (USD1.3 billion) of loans given higher oil revenues, according to Oman News Agency. In last month's USD1.75 billion tender for existing dollar debt the country elected to repurchase USD701 million. The agency reported on 7 July at in the five month period to end-May, state revenues grew 49.9% versus the same period in 2021 "due to a rise in oil prices…as well as growth in oil production". Overall state finances recorded a OMR631 million surplus versus an OMR890 million deficit in the same period of 2021. The Agency stated that the windfall will be used to "help support high-priority development projects" and "bring down the overall indebtedness".

Bermuda (rated A+ by S&P) has successfully advanced a funding and liability management exercise. It announced a cash tender on 11 July for USD756 million of existing bonds due on 3 January 2023 and 6 February 2024, in conjunction with the sale of a new USD500 million issue priced at a 210 basis point spread over US Treasuries. The new 10-year issue was priced with a 5% coupon and 99.348% issue price.

By way of comparison, on 20 August 2020, Bermuda had gained some USD10 billion of demand for an upsized package of 10 and 30-year debt, with the 10-year portion priced at a 175 basis point spread, with a 2.375% coupon (the 30-year bond bore a 3.375% coupon). This package also was linked to the repurchase of existing debt and the repayment of short term local bank credit lines.

A report in the Gleaner newspaper also claims that a USD200 million bond issue for Antigua and Barbuda is "back on track". In a parliamentary statement, Prime Minister Gaston Brown stated that a "new subscriber" is lining up to buy the issue in the next few weeks, after it was withdrawn earlier this year (February). He clarified that the earlier deal also had been fully covered but that it was pulled when the purchaser sought a far higher return. More specifically, according to Antigua Newsroom, the deal initially had been priced at "about six per cent as effective yield" but the investor then amended yield requirements and sought returns "in excess of nine per cent", which the government deemed "too expensive". The reference to a single purchaser for Antigua implies that the deal is a private placement. Given market trends between February and now, it is highly unlikely that the initial reported cost level would be matched: the government's success in managing the operation will be indicated by how much it is able to lower the cost from the yield of "approximately 10 per cent" previously demanded, and whether the deal is completed for the same size.

Slovenia's Nova Ljubljanska Bank also raised EUR300 million, paying 6% on 12 July for a EUR300 million three year deal callable after two years. The issue had been announced on 7 July. The bank had three prior issues outstanding, all in the form of subordinated debt.

Our take

In general, higher reference rates and outflows from riskier asset categories are generating widening in many emerging market spreads, in turn reducing borrower capacity to raise new capital market-based debt at sustainable cost levels.

As an example, Turkey's EMBI+ bond spread index has risen from a 2022 low of 493 basis points over US Treasuries on 22 April to a one-year high of 789 basis points on 13 July. On the same day, Egypt's EMBI+ spread stood at 1212 basis points, versus 654 on 5 January. Such deterioration implies that new dollar borrowings for both countries would need double digit coupons, in turn bringing into question the sustainability of undertaking such financings. Like Kenya, which recently cancelled a planned USD1 billion international bond sale to seek bank borrowings, Nigeria now also seems unlikely to return near-term to dollar markets, with its outstanding yield curve trading at over 11% and more for longer-term debt. Greater reliance on shorter-term bank funding, official bilateral and supranational lending all seem likely for multiple countries: for Turkey, for example, GCC funding now appears a high priority. Risk of wider debt distress appears to have risen, and to face the likelihood of further deterioration. In turn, this increases the number and range of countries likely to need IMF support, with Ghana having reversed its prior stance of rejecting IMF help (against a background of its outstanding international debt trading at yields around 20%).

Financial stress is more disguised elsewhere. Despite increased, very heavy debt stock burdens, Italian debt has rallied over the last month after the European Central Bank indicated it will design a new support mechanism for peripheral Eurozone debt once its wider asset purchase programme starts to be unwound. Nevertheless, its need to intervene leads us to conclude that Italy would face great difficulty in borrowing on a stand-alone basis without ECB market help, a problem likely to extend more widely within weaker EU states.

With inflation at new highs and reference rates currently only likely to rise further, tough market conditions are likely present severe challenges for a broadening range of borrowers during 2022.

Posted 15 July 2022 by Brian Lawson, Senior Economic and Financial Consultant, Country Risk, S&P Global Market Intelligence

This article was published by S&P Global Market Intelligence and not by S&P Global Ratings, which is a separately managed division of S&P Global.