Last week Argentina was able to borrow from international investors for the first time since 2001. It was the biggest ever one day issuance by an emerging market economy, raising $16.5 billion, with demand for the new bonds apparently as high as $70 billion.
This has understandably raised some questions about how much investors in these bonds have really thought about the risks involved. Lisa Abramowicz at Bloomberg’s Gadfly blog has summarised these concerns well. Some are worried that investors may be buying the bonds just because they may be added to a performance benchmark; others argue that investors are extrapolating the successful reforms of the new government into the future and ignoring the challenges that remain.
The biggest worry, though, is that the demand for Argentinian bonds is symptomatic of a global hunt for yield that has been driven by ultra-low policy rates around the world. We have spoken before about the idea of investors ‘climbing the risk ladder;‘ taking on ever more risky assets as the yields available have dropped.
The chart below illustrates this: you can see the yield fall below 5% on successively risky assets in the US as policy rates have stayed at zero (albeit with high yield bonds subsequently drifting back above this level).
Are US Dollar-denominated emerging market (EM) sovereign bonds the latest domino to fall? It would be understandable. The experience of holding EM bonds issued in US Dollars since 2014 has been positive; returns have been comparable with the S&P 500, and without the uncomfortable short term volatility.
In fact, based on monthly returns, US Dollar-denominated EM sovereign bonds have behaved much like similarly-rated US corporate bonds.
Charles de Quinsonas at Bond Vigilantes has discussed the similarly strong performance of Quasi-sovereign bonds and the rise in popularity of that asset class. Given these dynamics it would be easy to believe that investors are simply looking at top level yields, past returns, and nothing else. But is this true in Argentina?
Argentina: Pricing the unknown
The return of a government to the international bond markets provides a reminder of the difficulties in valuing sovereign government bonds. A whole range of forces influence a nation’s ability and willingness to pay, and the way in which the market perceives these is also influenced by the wider context. When a country has been out of the market for as long as Argentina has, you also lose the comfort of having observed how the bonds have behaved in the past and have to resort to first principles.
This should be a good thing, since a belief that history tells you much about the future is one of the worst errors that investors commonly make.
In the case of Argentina there are some interesting observations to make in this regard. In the absence of a recent history, investors appear happy to have priced the bonds at a yield which is comparable with other sovereign bonds with the same rating (and with similarly rated US corporates, though these tend to have lower duration).
However, simplistic assessments of solvency suggest Argentina is in a better position than some of its similarly-rated neighbours, and many other countries around the world.
This is unsurprising, since the nation hasn’t been able to issue in fifteen years, and has defaulted on most of the loans it did have.
This is an overly simplistic analysis, we have written before (using Japan as a case study) on how debt levels don’t always tell you much about bond yields or the likelihood of default. However, encouraging trends in policy should not be overlooked, nor should the fact that faith in a sovereign’s ability to pay can often become self-fulfilling.
In the case of Argentina it seems just as likely that investors are overlooking fundamentals because of the uncertainties associated with a previous default as they are to be blindly chasing yield.