Are EM corporate bonds really that vulnerable?

Since the end of October, emerging market dollar-denominated corporate bonds have performed much worse than comparably-rated US corporate bonds. This has been the result of increasing credit spreads amid concerns that the significant rise in the international debt of emerging market corporations since the last recession makes them vulnerable to a stronger dollar. However, we think spreads are more likely to fall, rather than continue rising, as the currencies of some countries where issuance has been largest are unlikely to depreciate much further, if at all. Indeed, the currency of the country where issuance has been largest – China – will probably continue to appreciate. What’s more, the valuations of emerging market corporate bonds are relatively low, which reduces the downside risk. For example the spread over Treasuries of emerging market dollar-denominated bonds with an average rating of BBB2 from Moody’s, S&P and Fitch is now more than 200bp greater than the spread over Treasuries of US corporate bonds with the same average rating. And it is also more than 60bp greater than the spread over Treasuries of US corporate bonds with an average rating of only BB2.