Nominal EM yields reached 7% yesterday for the first time since the depths of Covid in March 2020 and only the fourth time in the post-GFC era, on our measure (proxied by the sum of the ten-year US bond yield and EMBI spread). The nominal yield closed at 7.05% on 9 May, having risen 224bps this year, and 100bps just over the last month.
This compares to a post-GFC high of 7.5% on 19 March 2020, during Covid, and a post-GFC pre-Covid high of 7.4% in November 2018. It also compares to a post-GFC (and all-time) low of 4.15% at the end of 2020.
The rise in the nominal EM yield this year reflects a c150bps increase in US bond yields and a c70bps rise in the EMBI spread.
The main driver of the rise in nominal EM yields has, of course, been higher US bond yields with the normalisation of US monetary policy. The US ten year broke 3% on a closing basis late last week, the first time in over three years.
Meanwhile, the EMBI spread (a measure of country risk) has – surprisingly, perhaps – been relatively well contained at just c400bps, up just 70bps this year. It is not clear to us that this can last in this environment.
In particular, the spreads' resilience tests the old adage (well, our old adage) that a 100bps rise in US bond yields (the risk-free rate) translates into a more than 100bps increase in EM spreads.
Indeed, just looking at the EMBI spread one might even be forgiven for thinking what all the fuss is about in the market. The 400bps spread (402bps close 9 May) is roughly in line with the 20-year average (395bps) – although such a sample period would tend to inflate the average because of the high rates seen during the early noughties and GFC period – and is only 50bps wide of its post-GFC average (353bps); which is amazing given the state the world is in!
One might think EM country risk should be even higher given weaker growth prospects and declining trend growth rates across EM, the rise in public debt, challenges of fiscal consolidation, higher inflation, reform fatigue, political risks, and geopolitics. However, "self insurance" through reserve accumulation and institutional and policy-making reforms since the serial EM crises of the 1990s and 2000s have helped underpin EM sentiment.
That said, dealing with inflation at 20- or 30-year highs in some EM will be a major test (and perhaps the first major test) of those improvements in macroeconomic policy frameworks and central bank institutional arrangements that emerged across EM since the mid-1990s.