Emerging market governments and investors have issued near-record amounts of debt this month and cash-loaded investors, afraid to bet on stocks, have flocked to the relative safety of bonds.
Issuance in emerging markets has topped $35 billion so far in July, close to April's all-time record $40 billion and the $36 billion of March, according to ING Bank.
That super-sized issuance, which some analysts fear could be fueling a bubble in emerging markets, suggests limited risk appetite has returned as concerns over the European sovereign debt crisis ease.
But the demand for fixed-income instruments is also a sign investors are not prepared to ride the volatility in world stock markets and worry about the sustainability of the global economic recovery.
Investors are leery when it comes to equities; the longer-term growth outlook remains uncertain, said David Spegel, head of emerging fixed income at ING Bank in New York. It's better to put your money in fixed income, where you know what kind of coupon you're receiving.
However, investors are paying a high price for the relative safety of debt markets.
Brazil this week sold $825 million in reopened 2021 global bonds at a yield of 4.547 percent, the lowest in the country's history. Demand for the bonds reached $6 billion even as they paid investors only 150 basis points more than comparable U.S. Treasuries.
Brazil generated a whopping 7:1 bid-to-cover ratio, which speaks not only of sizzling global excess liquidity, but also of a disregard for the extremely rich spreads levels at which we have now arrived, Enrique Alvarez, head of research at New York-based IDEAglobal, wrote in a research note. For an Insider interview with Enrique Alvarez, please see: http://link.reuters.com/tyn32n
Chile, rated at least four levels above Brazil, on Thursday sold $1 billion in 10-year global bonds at a spread of 90 basis points over Treasuries, the tight end of a guidance range provided to investors.
Also on Thursday, Turkey issued $1 billion in reopened 10-year bonds at 5.25 percent, half a percentage point less than the country paid in March, when it first issued the bond.
Even Argentina might take the opportunity to issue bonds abroad after its 2001 default, following last month's cleanup of most of the remaining defaulted debt that was still in the market.
While investors believe the Argentine federal government will receive a warm reception when it decides to issue bonds abroad, Cordoba province said on Wednesday it will soon offer $250 million in global bonds with a maturity of seven to 10 years, depending on market appetite.
CASH BUILD UP
The rally in emerging debt markets also stems from supply-and-demand imbalances.
Cash piled up in investors' hands in May and June as concerns about the European crisis nearly froze international capital markets. Issuance during that period shrank to less than $15 billion -- a steep reduction from the pace of about $40 billion per month in April and March.
ING's Spegel calculates that investors accumulated some $20 billion in cash between May and June as a result of interest payments and amortizations of bonds that were not rolled over, as well as fresh investment flows into the asset class.
As a result, the cost for emerging market governments to issue dollar-denominated bonds fell on Wednesday to its lowest since early May, or 279 basis points over U.S. Treasuries, according to JPMorgan's EMBI+ index.
Adding some haste to the market is the upcoming U.S. summer vacation period, with some issuers rushing to close their deals before investors go away in August.
Some analysts, such is IDEAglobal's Alvarez, warn that the sharp market gains of the past few weeks may turn into pain for investors in the fourth quarter, when sentiment may deteriorate as a result of a coinciding economic slowdown in the United States and Europe.
But others see emerging markets bonds well-positioned to outperform most asset classes, even if the global economic recovery loses steam.
(Editing by Dan Grebler)