Morgan Stanley favors riskier EM bonds ahead of rate hikes

Morgan Stanley is urging investors to bet on some of the riskiest corners of emerging markets, just a day before the Federal Reserve make another large increase in interest rates.

High-yield bonds issued by developing countries have underperformed their investment-grade peers and even US speculative-grade debt. Despite this, the firm has favored bonds from Ukraine, El Salvador, Argentina and Ghana, among the hardest-hit instruments with some of the lowest ratings.

“Many parts of high-yield debt bottomed out for the cycle in late July,” James Lord and other Morgan Stanley strategists wrote in the report. “Our suggestion is to continue to buy the dip and be overweight high yield.”

emerging bonds

Emerging market dollar bonds are headed for their worst year on record, having fallen 17% due to the intense monetary tightening campaign of fed to control inflation.

The 10 biggest losers are all countries that have defaulted or are struggling to repay debt, including Belarus, Sri Lanka, Pakistan, Ghana and Lebanon.

For B-rated borrowers, markets are pricing in a five-year probability of default of 36% and 43%, with recovery rates of 40% and 25%, respectively, according to Morgan Stanley. The estimates are much higher than the historical long-term probability of default of around 15%, using an average of the three major rating agencies, the firm said.

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