Tight valuations Show How Hot Emerging Market Credit Is

Emerging market debt issuance is expected to slow, but remain elevated from the historical average as EM issuers rush to make the most of low rates and abundant liquidity according to Deutsche Bank credit strategists Hongtao Jiang, Rebecca Klausen, and Viacheslav Shilin.

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It is widely expected that the Federal Reserve will hike interest rates for the third time this year in December, and more hikes are expected next year as the US economic recovery continues. This backdrop of Fed tightening, pose a significant challenge for EM credit in 2018, however, "abundant global liquidity and suppressed European yields" should lead to a continued hunt for yield from investors ensuring that demand for EM bonds remains robust according to Deutsche's analysts.EM Credit Yield

Despite the Fed's actions, the environment for issuers is still highly favorable. Tight valuations so just how in demand this debt is with EM debt spreads (ex-Venezuela) trading at a post-financial crisis tights. The analysts note:

"Persistent inflows, supportive rates scenarios, and positive growth prospects have further stretched EM credit market valuation in 2017, as the EMBI Global Diversified benchmark has tightened by 50bp (to date), returning 9.6%. This performance is even more impressive if we take into account the record $175 billion sovereign gross issuances and a high profile -- albeit widely anticipated -- Venezuela default."EM Credit Yield

EM Credit Yield Hunt: Backdrop remains supportive

The team believes that the current environment will continue into 2018, although with spreads where they are today, " the scope of spread tightening is increasingly limited." Further improvements will rely on "both on the pull (fundamental improvement) and push (continued hunt for yield) factors."

That being said, it looks as if both of these tailwinds are present as we head into the new year:

"Fortunately, both of these factors are alive at the start of the year. While fiscal and debt dynamics are mixed for EM sovereigns, the synchronized global growth, benign EM inflation, much reduced external vulnerability, upside in commodity prices, and positive policy direction in some countries should help offset pockets of deterioration, a heavy election calendar and geopolitical conflicts, attracting more inflows – albeit likely at a slower pace in comparison with 2016-2017."EM Credit Yield

Total EM sovereign issuance of $145 billion is projected for 2018 vs. total repayments of $87 billion resulting in a net supply of $58 billion vs. the 2017 record of $98 billion and "significantly higher than the historical average."

The region's Deutsche's analysts are the most upbeat about are Argentina, Ukraine, Ecuador, Mongolia, Indonesia, and Turkey.

Caveat emptor