Blessed are the governments

By Buttonwood

WHEN Treasury bond yields fall to historically low levels, other markets are bound to follow. According to Stuart Culverhouse at Exotix, a broker, the yield on emerging market government dollar debt has dropped to 4.4% which is a low for the decade and very probably an all-time low.

Investors are very keen on extra income, just as they were in 2006 and 2007, and will flock to any asset class that provides it. Does that mean emerging market debt is a bubble? Not necessarily. Mr Culverhouse points out that the spread over Treasury bonds is 264 basis points, 115 points wider than it was in the summer of 2007. Emerging market bonds have followed a very similar path to US corporate high-yield debt, and do not look overpriced relative to that asset class.

A couple of other factors are working in favour of emerging market debt. First, the relative fiscal position of developing countries has improved dramatically relative to what Jerome Booth of Ashmore dubs HIDCs (highly-indebted developed countries). Today's sovereign debt crises are in Greece and Portugal, not Mexico or Brazil. Secondly, there used to be a fear that emerging market currencies would decline relative to the dollar, making it more difficult for governments to service their debt. But given their current account positions and faster growth rate, one might expect many emerging market currencies to rise against the dollar over the medium term; making it easier for them to service their debt.

Of course, if Treasury bond yields shoot up, then emerging market yields will rise with them (and the bonds fall in price). But it seems likely that the Fed would do a lot more QE if that happened to try to force yields back down again. In a sense, the Fed is delivering lower borrowing costs for Brazil and Russia. Let us hope they are grateful.