Will the surge in the EMBI+ spread be reversed?

The “stripped” spread over US Treasuries of the JP Morgan EMBI+ Index of emerging market dollar-denominated government bonds has risen by a further 40bp over the past month to around 4.2%, well above its average of the past ten years. However, we are not convinced that the spread will fall back significantly anytime soon. Its rise has primarily resulted from surges in the spreads of bonds issued by oil exporters Russia and Venezuela, who together constitute around 16% of the market value of the index. Although we expect oil prices to rebound a little, we think they will remain low by the standards of the recent past – our end-2015 forecast for Brent crude is $60 per barrel. If we are right, this will keep the finances of both countries under significant pressure. Of course, the spreads of bonds issued by other countries in the index could conceivably decline, dragging the spread of the overall index lower. But we calculate that the stripped spread of the remaining index is only around 2.9%, which is broadly similar to the spread of comparably-rated US corporate bonds over Treasuries. Accordingly, the scope for such declines may not be that great.