As we move into the final quarter of 2021, our emerging external and local debt valuation measures are moderately more attractive than they were at the start of the quarter:
- External debt valuations remain within the historical range which we consider broadly neutral.
- In local debt, Emerging market currencies (EM) continue to remain at attractive levels, having remained at the very top of the neutral band throughout the quarter, while real interest rate differentials between emerging and developed markets ( MD) continued to widen.
In this article, we update our scorecards and feedback, with additional details on our methodology available on request.1
External debt assessment
The EMBIG-D benchmark widened 17 bps in the third quarter, ending the quarter at 357 bps. As shown in Table 1, the fair market multiple is the credit spread of the benchmark over the spread that would be needed to compensate for credit losses. This ratio increased slightly during the quarter. The multiple was 2.5 at September 30, 2021, compared to 2.4 at June 30, 2021. We estimate the threshold range of the credit multiple by analyzing the relationship between the returns of two-year EMBIG-D credit spreads. following and the credit multiple historically. A level above the upper range of the threshold (currently 2.8) has historically been associated with positive credit returns, while a level below the lower range of the threshold (currently 2.0) is more associated with returns. negative credit over the next two year period. This estimate of the threshold range is recalibrated on an annual basis. A level in this range would be considered neutral, which is where the market valuation drops at the end of the quarter.
The widening of credit spreads was the main reason for the small increase in the multiple over the quarter, as the denominator of the multiple – the fair value spread or expected credit loss – fell only 1bp to 142bp at the end of the year. September. Regular readers will recall that this fair value differential is a function of the weighted average credit rating of the benchmark, as well as historical sovereign credit transition data and an assumption on salvage values in the event of failure. fault. Regarding the third quarter, the fair value difference was influenced by a few downgrades, notably Kuwait (AA- to A + in July) and Ethiopia (B- to CCC + in September). Additionally, while Panama, Sri Lanka, Peru and El Salvador were placed on negative outlook, Jamaica was placed on stable outlook and Oman was placed on positive outlook.
The above was a discussion of the level of spreads, or credit cushion. From a total return perspective, the level and changes in the underlying risk-free rate are also important. In the third quarter, yields on US Treasuries were virtually unchanged, with the 10-year rate increasing by 2 basis points and having little impact on benchmark returns. We measure the “cushion” (which we use as the slope of the forward curve) in Treasuries by the slope of the 10-year swap rate forward curve, represented by the clear font lines in the table. 2. As Long Term Yields on US Treasuries were essentially unchanged during the quarter, so was the slope of the 10-year forward curve; However, as the slope ended the quarter at 47 basis points, the same level as in the previous quarter, the entire curve has shifted upward by about 15 basis points, likely reflecting the anticipation of a reduction in Fed bond purchases and impending rate hikes. This indicates that the market is more anticipating the rise in rates, as the forward curve represents the trajectory that would make an investor indifferent to holding treasury bills and cash. We see this as positive compared to the previous quarter.
Read on with the graphics here.
Also check out: