Will rate hikes reduce liquidity and accelerate emerging market debt restructurings?


Moreover, when restructuring was required, salvage values ​​averaged 55 cents on the dollar, a level well above that of corporate bonds. Already right now, many distressed bonds are trading around or below the average salvage value. The JP Morgan Emerging Market Bond Index Global Diversified is also more diversified in 2022 than it was in previous Fed rate hike cycles, reducing the concentration risk of an isolated default.

When analyzing emerging market debt yields in the year since previous Fed rate hike cycles, we don’t think investors should be overly concerned. Although each cycle we have analyzed involves unique global economic factors, emerging market debt returns in the 12 months following the start of a rate hike cycle have been strong, as shown in the chart below. below. Double-digit returns of 14.67%, 18.44% and 10.15% were recorded 12 months after the top notch increases of 1999-2000, 2004-2006 and 2015-2018, respectively. And in each case, spreads tightened on the upsides.

In each of the past rate hike cycles we’ve looked at over the life of this asset class, high-yield emerging market debt has outperformed higher-quality emerging market debt over the past 12 months. following the Fed’s first rate hike. We expect the current tightening cycle to be no different. The spread differential between high yield and investment grade is trading at historically wide levels. In addition, spot prices are low across the asset class and the number of bonds trading at distressed levels has already reached an all-time high, with C-rated bond prices already averaging around $30. which is well below history. recovery levels.

We therefore think it might be worth overweighting the high yield sector at the expense of higher quality bonds which offer less probability-weighted upside potential and seek to take advantage of distressed credit valuations.

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