Crude dollar shakedown

Takeways:  The impact of dollar and oil trends on divergent emerging markets caught our eye this week. A timely reminder to check and update plans for different geographies and sectors and realign strategies. As with so much these days, past performance is no guarantee of future growth. Although some things don’t change: Greece is the word once again in Europe. Meanwhile, borrowers have never had so many debt options available to fund their strategic plans. In low growth environments these plans increasing include cross-border M&A to combat against downturn and deflation. The year ahead is shaping up to be a complex and interesting time with new risks – but also great opportunities.

The slings and arrows of divergent fortune

A resurgent dollar, a more tentative China and plummeting crude – a heady mix for developing nations already in the midst of a welter of other economic and political tensions. Assessing the impact means picking through the nuances and recognising the increasing divergence of nations lumped under ‘emerging’ and other headings. ‘BRICS’ is so old-school. ‘Fragile-five’ feels so last summer now India has begun to reform. It’s a complicated emerging market universe, which will react distinctly to these varied and multi-layered challenges.

Emerging markets generally follow China’s economic drumbeat, but the pulse is slowest for commodity and industrial suppliers, hitting countries like Peru and Chile harder than consumer-oriented Brazil.  The falling price of crude obviously has a mixed impact, helping intensive energy users and importers – like India and Thailand – but presenting a nightmare for fiscally challenged oil exporters like Venezuela. However, cheaper oil is also beginning to stifle the flow of US dollars around global markets – as we’ve discussed previously. This leaves countries like Brazil, who’ve taken advantage of cheap dollar-loans, facing more expensive payments with a more elusive and more expensive greenback. Gisele certainly wouldn’t be paid in Euros today.

The rising dollar is a particular concern, The Bank of International Settlements (BIS) reports that emerging market borrowers have issued a total of $2.6tn of international debt securities, of which three-quarters were denominated in dollars. Cross-border lending in dollars has tripled to $9tn in a decade.  With the dollar index at an eight–year high and emerging market currencies at a 14-year low this obviously stirs memories of 1980s Latin America and 1990s Asia, when countries and companies struggled to pay their dollar-denominated debts.

There has been a concerted effort amongst many of the most vulnerable nations to strengthen their balance sheets. It feels like a time to be watchful, rather than panic. The ‘taper tantrum’ proved a useful warning, one which brings us to the crux of the issue. There may be increasing emerging market divergence linked to ‘outrageous’ China, oil or dollar fortunes. However, some of the greatest divergence could be between countries who have taken steps to build resilience against such slings and arrows and those who have not. On that basis, reformers like India should fare best – so long as they don’t fall foul of post-election complacency. 

Russian chills

Corporate Development Officers (CDO) tell us that most emerging markets remain ‘on the table’ in terms of deals and expansion. However,  increasing curious shareholders are asking more pertinent questions about their exposure. One of the most referenced countries is, unsurprisingly, Russia.  Sanctions have made doing business more difficult and hastened capital outflows. The rouble is the worst performing major currency in the world this year. Central bank reserves are still strong, but not unlimited and currency defence at this level can be ruinously expensive. The other option is to raise interest rates – which the central bank could do this week – but the country is already facing recession. The price of Russian credit-default swaps has jumped past Iraq and Lebanon this week, making Russia the ninth riskiest country in the world in CDS terms. 

European lender exposure looks manageable at face value – although it never works out at face value. However, perhaps the area to watch most closely for now are dollar debts of around U$715tn in Russia and in areas still strongly linked to Russia through Soviet ties. As their currencies strengthen against the Euro, this hits trade creating a devaluation conundrum. Kazakhstan was forced into 19% devaluation in February and could be close to acting again. 

Greece is the word – again

Greece can’t exit its bailout in 2014.  The government has decided to use a two-month Troika extension to hold parliamentary presidential elections – presumably to avoid holding them after it’s agreed more austerity. It’s unlikely to win enough support to vote in a President, so a General Election will be called. Anti-austerity party Syriza is the favourite to win. The Greek stock market has fallen by 10% today – down 27% this year. Greece is back.

As Syriza draws closer to power it has softened stance on a debt moratorium, but any doubts over the ability or willingness of a member to honour their debt isn’t going to convince Frankfurt’s QE doubters. However, set against this we have market expectations that are approaching no return – QE is priced in to the point where the ECB has to change policy because it’s expected as much as needed. This all goes to underline the BIS’ other concern that markets’ buoyancy hinges on central banks’ “every word and deed”.

Exciting times in credit

It’s this liquidity – along with the increasingly wealth of options – that should ensure 2015 remains another exciting year in European credit markets. Our latest Credit Market Report  reviews what was, without doubt, another great year for credit markets in 2014. In 2015 we expect further innovation, new market entrants to improve liquidity and bulging corporate acquisition pipelines starting to deliver deal flow – particularly in the mid-market.

Certainly in investment grade, we’ve seen margin compression and covenant flexibility creating the best credit market conditions since 2007. Borrowers have taken advantage of the positive environment and competitive tensions to ‘amend and extend’ their debt and we expect more of the same in 2015, in addition to an increasing proportion of M&A funding. Pipelines are growing as companies adapt to the new post-recession world. In particular we expect an increasing amount of cross-border activity, especially from companies facing low-growth and potential deflation at home.

There’s a more complex picture in high yield bonds.  European issuance has already reached a record high; but 78% of this came before the end of July, according to Dealogic. Geopolitical concerns and the high-profile collapse of Phones 4U have rocked investors’ confidence, whilst secondary market liquidity remains an ongoing concern.  However, many more options are opening up. The mid-market is especially active and exciting. Direct Lending Funds are certainly coming of age. The private placement market is rising in popularity amongst companies looking for an alternative to traditional bank lending. The US market is obviously the most prominent, but European equivalents are growing, with efforts afoot to foster a pan-European market.  Private placement does have its challenges: the need to ‘make whole’ and for roadshows – but they’re another part of the toolkit and it’s great to see more options opening up.

You can also read more about private placements in our latest edition of ‘Capital Insights’.


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