ROSS
A WALL Street-driven-sell off has affected the prices of all emerging market debt, including even Jamaica's international Eurobonds. These were until recently trading at all time highs, as the vast majority of emerging markets benefited from the historically low interest rate spread of emerging market debt generally over risk- free U.S. treasuries.
This spread, measured by U.S. Investment Bank J.P. Morgan's emerging market bond index (EMBI), reached historic lows on May 1, but has since increased sharply although it remains at historically low levels.
According to Bear Stearn's economist Carl Ross "The EMBI+ spread reached its all time low on May 1, at +173 basis points (a basis point is one hundredth of one percent) over U.S. Treasuries (UST). The most recent reading is +225 over UST, compared with the 12/31/05 number of +245 over UST. So it has been a significant sell-off, but we are still not back to beginning of the year spreads. The total return of the EMBI+ year to date is -0.65 per cent."
What this means is that before, an average emerging market country might have been able to borrow for ten years on the international capital market at about 6.7 per cent (compared with a ten year U.S. treasury bond yielding five per cent), whereas now the rate for that borrowing would be about half a percent higher at 7.25 per cent, although still below the rate at the beginning of the year.
"Emerging market debt issuance has fallen dramatically in recent weeks since about May 8, which I think was the peak of the market," Carl Ross said. "Most of the sell-off has been expressed in global equities, but there clearly has been an important widening in spreads in sub investment grade bonds."
Perhaps unsurprisingly in view of its high percentage of foreign ownership, the most recent 2036 Jamaican Eurobond issued in February (which even before the sell off was slightly below its offer price) has borne the brunt of the correction in the Jamaican Eurobond market in price terms. However, with the exception of some of the shorter majority Jamaican owned issues, the rise in yield has been around half a per cent for Jamaica's U.S. dollar issues, suggesting that they have fallen in line with the international market sell-off, and not specific factors to Jamaica.
Mr. Ross adds, "Luckily, the Jamaican Government has completed its financing needs for the year. In hindsight, this has turned out to be prescient. The emerging market dollar debt markets are by no means panicked, but returns have essentially been flattened for the year-to-date, and the market still faces strong headwinds from Fed (U.S. Central Bank) uncertainty and some bearishness over the global growth outlook."
WHY IS EVERY MARKET DOWN?
The key to this across the board fall is likely to be the change in the policies of the major central banks. In a presentation at the PSOJ Economic Seminar on May 30th, Mr. Chris Gilfond of Citigroup Global Markets argued that after an exceptional first quarter global economic growth rate, the Central Banks of the U.S., Japan and Europe resumed monetary tightening to address inflation concerns. In his view, rising interest rates and recent economic data have prompted revisions to the global growth outlook, creating volatility in international markets and particularly in the emerging market asset class. In his view, the price of risk had fallen as leveraged investors 'hedge funds' had come to comprise up to 40-50 per cent of emerging trading, which is now in the process of being reversed.
While it is widely known that the central banks of the world are now removing the massive amounts of liquidity that had driven asset prices around the world, what is less well known is the critical role of the Japanese Central Bank, described as the 'marginal provider of liquidity in the system' by Citibank's Global Strategist Ajay Kapur. According to well known international financier George Soros, over the past few months the Japanese Central Bank has withdrawn the equivalent of US$200 billion in excess liquidity from its financial system, and this sharp fall in its monetary base has had a worldwide impact.
