Emerging markets bond pain may barely have started

Singapore - Emerging market bonds have been the asset to dump since Donald Trump was elected as US president.

The selloff has been so virulent that some investors may be tempted to think they're now cheap. They aren't, at least not by historical standards.

Investors sold almost $5bn of bonds in Asia's local-currency debt markets in the week following Trump's victory, and Blackrock's iShares MSCI Emerging Markets ETF saw its biggest outflows since January 2011.

Overall, investors last week withdrew $715m from exchange-traded funds focused on developing-nation debt.

The result has been a sharp drop in most gauges that track the asset class. The Bloomberg Barclays Emerging Markets Hard Currency Aggregate Index has logged a 3.65% loss since November 8, erasing almost a third of this year's gains before Election Day.

So, has the pendulum swung too far, too fast? On the contrary: if anything, it's moving too slowly.

Current premium and five-year average

287 basis points vs. 338 basis points

At 287 basis points, the premium that developing-nation dollar bonds pay over Treasuries is still far from its five-year average of 338 basis points. That can be explained partly by the speed of the movement in Treasuries - the yield on the 10-year US bond has risen 45 basis points since November 8.

Being less liquid, emerging market bonds are taking longer to reflect this new reality.

That's bad news for investors. So far, price changes have been concentrated in the most liquid securities. As the adjustment starts to spread, moves will become more violent.

When dealers see more people selling bonds that are seldom traded, they tend to move bids to levels that they consider cheap and that they know vendors are unwilling to accept. Traders call that defending your book.

This phenomenon could be further exacerbated by the lack of liquidity that typically marks December.

In other words, average spreads may be just starting to catch up with the general trend. If emerging market bonds don't stabilize in the next couple of weeks, the next round of selling could be a lot more painful.

This column does not necessarily reflect the opinion of Bloomberg and its owners.