EM Sovereign Debt: Spreads Are Tight... So What?
A superficial look at EM sovereign spreads suggests they may be too tight to offer attractive upside. We disagree, and here’s why.
A cursory look at EM sovereign debt over the past 20 years leaves most observers with the impression that spreads in the asset class are too tight and valuations are expensive, and therefore do not offer good risk-reward potential. Spreads of BBB, BB, and B-rated sovereigns are indeed testing multi-decade lows (Figure 1), which prompts two questions: Is a market “correction” likely, and if so, will potential returns be adequate?
Figure 1: EM Sovereign Spreads Test Multi-Decade Lows
Source: J. P. Morgan. As of May 31, 2024.
If our analysis was limited to looking at spreads over the past 20 years, then we too might conclude that they are tight and that EM sovereign credit is expensive. However, a number of factors lead us to remain constructive on the asset class.