Comment: Outlook for Emerging Market debt

All of that volatility seen so far in emerging market bonds this year is totally independent from the events (which are actually positive) taking place in emerging countries (with the exception of Brazil).

In most emerging countries, high oil prices continue to support strong balance of payments, high reserve positions and improving fiscal balances. Also politically, most countries offer the potential for either improvement of continuing stability. Thus, fundamentally, emerging countries are doing well.

 However, during most of 2004 so far, emerging market bonds have been slave to the movements in US interest rates. The market fears are that interest rates will be raised in the United States and that as a result, investors will begin to sell emerging bonds, causing the EMBI Global (benchmark) spread to widen.

Unfortunately, especially in the last month, US economic numbers have shown that there is a possibility that the long US recession is over with. As a result, desperate market participants, who have long been waiting for a recovery, put all their chips on the recovery story, creating a strong momentum against bond investments (including emerging market bonds).

We believe that one should require more than one month of good economic numbers to determine the end of the current low interest rate environment and are thus eager to see at least 2 more months’ worth of data before assuming that US interest rates will be raised. It seems that the Fed feels the same way, maintaining its neutral stance in its last meeting.

Therefore, we will maintain our cautious stance within the emerging markets until further signs direct our US interest rate view. Nevertheless, we are prepared to shift our focus to spreads when it becomes clear that the interest rate cycle has turned.

When that happens, we will hopefully be able to still benefit from the emerging countries’ strong fundamentals by investing in their spreads, not just bond prices. That moment has not arrived yet.