Emerging debt returns plunged more than 2 percent in June, their worst performance in 13 months, hurt by concerns about the US subprime mortgage market and a spike in Treasuries yields. The sell-off slashed almost all of emerging debt gains in the first half of the year, while risk spreads over US Treasury notes jumped to a three-month high.
Default rates in the subprime segment of the US mortgage market have jumped in recent weeks, raising fears that the crisis might spill over into other areas of the economy. Concerns that some hedge funds could be in trouble also grew after Bear Sterns had to bail out one of its funds exposed to the subprime mortgage market, helping reduce risk appetite.
"Financial markets seem to be becoming more arid every day, as liquidity is starting to dry up in many markets," wrote Richard Bernstein, chief investment strategist for Merrill Lynch in a research note. "This is not to say that the liquidity-driven period to which investors have become so familiar is over, but borrowing costs are indeed going up," he added.
Emerging debt returns measured by the J.P. Morgan's EMBI+ index fell 0.18 percent on Friday, increasing its June losses to near 2.3 percent, the biggest fall since a 2.44 percent decline in May 2006.
Year-to-date returns of near 0.2 percent are also disappointing, after gains of 10 percent in 2006. In the beginning of the year, most analysts expected emerging debt markets to return something around 7-8 percent in 2007, but those figures now seem to be out of reach. A few weeks ago J.P. Morgan said it expects gains of less than 3 percent for the whole year.
Argentina and Venezuela had the worst performance in the year, with losses of more than 10 percent. On the other hand, Brazil and Colombia rose around 3 percent and 4 percent respectively, buffering the market. Emerging debt risk spreads widened 10 basis points on Friday to a three-month high of 175 basis points, frustrating a traditional end-of-month rebound in the market.