Back in August 2011, the European debt drama kicked into a higher gear, sending investors scrambling for safety and punishing emerging-market bonds and currencies. By October that year, the premium paid on developing-world dollar bonds over Treasuries hit 447 basis points, a mark topped only in 2020 at the height of Covid. That spread is around 189 basis points now.
Contagion fears have crept back as the gap investors require to own French government bonds instead of German ones climbed to its widest since 2011. A run-up in oil prices tied to the wars in the Middle East and Ukraine has added fuel to the worry list.
"Compared to 2011, EMs are better positioned today, with stronger fiscal dynamics, external balances, and high nominal yields that provide structural resilience," according to Carol Lye, who manages funds at Brandywine Global Investment Management in Singapore. She also noted that positioning in EM currencies is relatively light, which could reduce forced selling if Eurozone stress flares. Brandywine has boosted its positions in Latin American currencies and maintained stakes in North Asian currencies that are gaining from artificial-intelligence-related spending.
"Emerging markets are well positioned," said Eric Fine, VanEck's head of active EM debt in New York. "They are generally sound credits with independent central banks that have already navigated crises." He added, "EMs broadly would be winners, as they represent alternative reserve assets."
The backdrop helps: even as 10-year Treasury yields pushed above 5% last month to a level last seen in 2002, a Bloomberg gauge of global EM local-currency debt closed Friday yielding 4.21%, little changed over the month.
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There are still soft spots, especially where budget deficits are widening. "Liquidity can deteriorate much faster than economic fundamentals," warned Lyndon Man, co-lead of Invesco Global Investment Grade Credit in London, adding that markets can quickly fixate on fiscal weak links.
Brazil is front and center. The country's nominal fiscal deficit has climbed to nearly 10% of GDP and public debt now exceeds 80%, testing investor nerves. Even so, Brazilian assets rallied last week as the more market-friendly Flávio Bolsonaro pulled ahead of Luiz Inácio Lula da Silva during the first round of the presidential vote. The key question, Man said, is whether better sentiment after recent political developments is matched by credible steps on fiscal policy.
Macro Hive Ltd. sees particular vulnerability in Central and Eastern Europe. "CEE member countries of the EU would be the most vulnerable in emerging markets to any disruption within the Eurozone itself, given that their economies and monetary policies are so intertwined," said Simon Quijano-Evans, a senior EM strategist at the firm in London. Poland has felt the strain, with Moody's Ratings cutting its sovereign score by one level to A3 in September.
For some, a selloff tied to Europe could be a chance to add risk. "The 2011 debt crisis ended up being a massive buy opportunity," noted Edwin Gutierrez, the London-based manager responsible for EM sovereign debt at Aberdeen Investments. He expects EM debt to be less reactive to moves in European government bonds this time.
Aberdeen is favoring local-currency bonds across frontier markets including Nigeria, Egypt and Kazakhstan, contending that these securities are less influenced by rate moves in developed economies. Pair that with Brandywine's tilt toward select Latin American and North Asian currencies, and you get the picture: managers are picking their spots rather than bailing out wholesale.
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