By Ben Robins, Emerging Markets Debt Portfolio Specialist at T. Rowe Price
After a significant amount of speculation and consternation over a possible default, Russia has initiated coupon payments on two of its dollar bonds. This was a relief to markets, and the price of the bonds rallied on news of the payments. However, it should not be taken as a firm indication of what might happen to the rest of Russia’s foreign currency bonds, which total over approximately USD 40 billion.
The ongoing war in Ukraine has caused Russia’s external government bonds to decline rapidly to levels that imply a default is highly likely. Even so, a default on sovereign debt is an extremely rare event and, if it is declared, this will be the first time it has happened in Russia since 1998.
Emerging markets are likely to remain volatile in the near term
More broadly, emerging markets (EM) are likely to remain volatile for the time being. EM bond spreads have widened recently, with investor sentiment knocked by both the Ukraine crisis and the prospect of monetary tightening from major central banks such as the U.S. Federal Reserve. As a result, EM bonds have been hit by outflows, a trend we expect may continue in the near term. We are assessing what the potential impact of J.P. Morgan’s decision to remove Russia from its EM benchmarks on March 31 may be on other emerging markets.
We believe there are two primary channels for the situation in Ukraine to spill over into emerging markets more broadly: commodity prices and financial flows. For commodity importers, such as India, rising commodity prices are a negative in terms of trade shock, which will probably drain income from the economy and generate inflation, leading to activity slowing. For commodity exporters, such as Brazil, rising commodity prices are a positive in terms of trade shock, which will likely drive economic activity and credit improvement. Inflationary pressures may lead to EM central banks hiking more and holding rates higher for longer. So far, this has led to only modest repricing in EM local rates given that aggressive hiking paths were already priced in to a certain extent.
Remain constructive on EM debts but fundamental research is vital to navigate volatility
During times of volatility, we believe it is vital to stick to our investment process, which is centered on fundamental research and takes a long‑term investment perspective. With that in mind, our view is that the recent spread widening has helped to improve valuations elsewhere in EM debt, and we therefore remain constructive on the asset class. We are approaching yield and spread levels that make EM debt attractive relative to other areas of fixed income.
