Fitch: US Investors See EM Contagion as Top Market Risk
In the survey, which closed 9 October, 60% of investors said adverse developments in one or more EMs pose a high risk to US credit markets, while 40% said the risk was moderate. None thought it was low. Investors saw Brazil and China as the two most likely sources of wider EM contagion, trailed by Russia and Turkey.
Nearly three-quarters of those surveyed picked EM corporates as their least favourite investment choice; 93% said they expect fundamental credit conditions for EM corporates to deteriorate over the next year.
Fitch sees EMs as an increasing source of risk to global growth as the collapse in commodity prices and political shocks exacerbate a secular slowdown. EM bonds were boosted in the last decade by investors' search for yield and increased funding disintermediation in local debt markets. This makes EM borrowers vulnerable to rising US rates and the reversal of previously strong capital flows.
Brazil, along with other Latin American countries, faces weakening fundamentals. The economy is in recession and facing fiscal and political challenges. Currency depreciation and volatility has taken a toll on domestic confidence. Brazilian corporates face rising domestic and international financing costs, while credit access abroad has dried up for high-yield issuers. At the same time, the Brazilian Development Bank is redirecting lending away from many corporate sectors. A continued downward trend in corporate ratings is likely, leading to an increased concentration of ratings in sub-investment grade territory.
Possible contagion risk from a slowdown in China was one of the factors that contributed to the Fitch Fundamentals Index, a broad measure of US credit conditions, turning negative in 3Q for the first time since 4Q09. Concerns about growth and the turmoil following China's August currency devaluation led to a significant reduction in risk appetite and a widening of credit default swap spreads that dragged on the index.
A China hard landing, with GDP growth falling to 2% in the next couple of years, was also the most immediate of the key global risks highlighted in our 3Q15 Risk Radar. This scenario would be negative for issuers in many commodity-exporting EMs as well as companies and developed market countries dependent on global trade.
Fitch's survey represents the views of 74 senior fixed-income investors. We will publish the full results in early November.