So far this year some of the top performing currencies against the dollar are the offshore and onshore Chinese renminbi, and the Japanese yen. At the time of writing, the offshore renminbi is up ~2.5% and the yen has gained 1.45% against the greenback. On the other side of the spectrum the Argentine peso, Turkish lira and Brazilian real are amongst the worst performers year-to-date; having fallen roughly 23.5%, 16.5% and 10%, respectively.
Used to identify currency and bond positioning, regular readers are aware of the Net Foreign Assets scoring system. The model considers the indebtedness of a country and hence its ability to repay debt, thus enabling the user to identify the wealthier nations within which to invest. As an example, Abu Dhabi and China are considered “wealthy” having Net Foreign Assets above 100%, and 25% of GDP, respectively, while Brazil, Turkey and Argentina have large Net Foreign Liabilities.
Despite some investors hugely supporting debt issued from Argentina, Brazil and Turkey, we have never favoured sovereign, quasi-sovereign or corporate issuance from those countries due to their: indebtedness, current junk status and insufficient spread cushion. We could demonstrate this using the expected risk-adjusted relative value of 30-year sovereign USD benchmark bonds from Abu Dhabi and Brazil. Rated Aa2, Abu Dhabi Government 4.125% 2047s trade almost 90bps wider than similarly rated bonds with a duration of ~16 years, thus offer an expected return of 14.5%, yield of 4.75% and roughly 4.5 notches of credit cushion. Meanwhile, Brazil 5.625% 2047s, may have a higher yield of 6.3% but they trade at a tighter spread compared with other Ba2 rated bonds with a similar duration; at ~315bps while similar bonds are priced at ~345bps. We therefore calculate that the bond is 0.46 notches “expensive”, with an expected return of -3.7%.
Yield hungry investors have even been buying B2/B- rated Argentine debt, despite the country’s deepening economic woes. The 6.875% 2048 USD issue for example yields over 8%, but only offers and expected return of just 1%, with almost no downside protection, at 0.10 credit notches. It is therefore quite clear to us what we would rather avoid holding both in terms of currencies and bonds.