Morgan Stanley More Bearish on EM Debt as Funding Costs Increase

(Bloomberg)--Morgan Stanley turned more bearish on sovereign and corporate debt in emerging markets as declines in their currencies accelerated and funding costs increased.

The U.S. bank cut its recommendation on foreign-currency bonds to “sell” from “reduce,” and on local-currency notes to “reduce” from “hold,” strategists led by New York-based Rashique Rahman wrote in a report dated yesterday. Argentina’s peso and Turkey’s lira have led declines in exchange rates of developing economies this year as the Federal Reserve began paring stimulus that had fueled demand for their assets.

The premium investors demand to hold emerging-market sovereign debt over U.S. Treasuries widened 39 basis points this year to 366 basis points on Jan. 27, after touching 368 on Jan. 24, the highest since September, according to JPMorgan Chase & Co.’s Emerging Bond Index Global Sovereign Spread.

“Valuations in credit markets stand out the most to us as being rich, and we expect recent spread widening to continue,” the analysts wrote. “The recent foreign-exchange weakness and increased cost of funding are set to generate a negative feedback loop from the external into the domestic fabric of emerging-market economies.”

China’s yuan is the only one among the 24 major emerging currencies tracked by Bloomberg to advance against the dollar this year.

CURRENCY WEAKNESS

Developing-nation currencies fell for a ninth day on Jan. 24 to the weakest since March 2009, according to JPMorgan Emerging Markets Currency Index. The Argentine peso has dropped almost 19% this year versus the greenback, the worst performance among emerging currencies, Turkey’s lira weakened 5.5%, Russia’s ruble declined 5.4% and the South African rand fell 5.1%, data compiled by Bloomberg show.

Emerging-market bond funds saw outflows of $430 million in the week through Jan. 22 after withdrawals of $774 million in the preceding week, according to Australia & New Zealand Banking Group Ltd., which cited EPFR Global data.

Morgan Stanley maintained its “underweight” recommendations on foreign-currency debt from Turkey, Brazil and Ukraine, meaning investors hold less than the benchmark index recommends. The bank said it expects notes from Mexico, Russia, Peru, Hungary and Romania to outperform, according to the report. It also predicts corporate credit in emerging markets will underperform sovereign debt in 2014.