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Capital Markets Weekly: Supply continuing but markets indicate greater caution

31 May 2019 Brian Lawson

May market overview

Unsurprisingly, equity markets have reversed during May after the increase in US trade tariffs against China and the threat of further measures. As of 29 May, China's CSI300 index has lost over 6.5 percent during May, with the DJII nearly 5 percent weaker: the MSCI Emerging Markets index is close to nine percent down. Emerging market bond spreads have widened. The global EMBI+ spread index has widened 4.37% (to 29 May), but several countries including Colombia, Indonesia, Mexico, Philippines, Peru and Turkey have experienced double-digit percentage spread increases.

While its performance has been weak, the completion of the Uber IPO - rather than it being delayed - perhaps should be deemed a positive risk indicator. Its shares remain below issue price - at USD40.89 on 28 May versus USD45 at issue - but this heavily reflects short selling. According to IHS Markit data, short positions against Uber have increased from 13.6 million to 36 million shares in the last two weeks, with short positions now exceeding USD1.5 billion.

Given greater concerns over the global economic trajectory, bond markets have rallied over the month, with both US Treasuries and Bunds trading to new 2019 lows. The Treasury market rally came despite heavy media focus on China having reduced its US Treasury bond holdings in March, sparking speculation that it would trim such holdings as a leverage tool within the current trade dispute (a view we do not yet share, especially as it added to its US bill holdings).

Despite a modest widening in risk spreads in bond markets, new supply is continuing within emerging markets. This week's most significant debt sale was by Guatemala, which raised ten and 30-year debt. The Dominican Republic is undertaking investor marketing this week ahead of pending issuance, reportedly of a dollar and local-currency bond. There has also been further debt supply involving Chinese borrowers.

Key new developments

Guatemala sold USD500 million of 10-year debt at 4.9%, and USD700 million of 30-year liabilities at 6.25%. Demand reached USD3.3 billion with 150 investors involved, according to Guatemala's Public Finance Ministry, which described the deal as part of a process to diversify funding sources to involve the local market, multilateral lenders and international markets.

Dominican Republic also is meeting investors ahead of a planned bond sale, potentially in US Dollars and local currency. Treasury Minister Donald Guerrero recently confirmed that the country was preparing a deal and would issue "soon". He had cited US/China-related market volatility and a domestic effort to block the proposed budget as delaying factors: the latter was removed by a pro-government ruling by the country's Constitutional Court. The 2019 budget included plans to raise up to USD2.25 billion from global markets (versus USD2.4 billion from two dollar sales in 2018).

According to Latin Finance, Chile's next international issue will be a Green Bond, reflecting a goal of investor diversification along with the country's environmental credentials. An eventual Green issue could cover a significant part of the USD1.5 billion Chile has indicated it will raise from international markets. The remainder of its funding will be conducted in local currency debt.

Equity

Media reports claim Chinese internet firm Alibaba is planning a secondary listing in Hong Kong, potentially raising up to USD20 billion in equity at the same time, as soon as the second half of 2019. The company was floated in New York in 2014, raising a record USD25 billion. The Hong Kong Exchange altered its listing standards last year to encourage more technology-sector issuance even if the companies' voting rights fail to align with general local standards. Alibaba has not commented on the widespread reports.

Our take

Earlier in the year, we commented on the apparent paradox of both debt and equity markets rallying in parallel. While unwinding of short selling from late 2018 was a contributing factor, we view the main driver to have been both the US and EU moving to a softer monetary policy stance than previously expected.

Market reaction to new trade uncertainties now matches our expectations. The risk of slower growth for the global economy has damaged equity valuations and led to wider debt risk premiums, while triggering bond market rallies.

While emerging market spreads have deteriorated, the search for yield and duration has supported further supply without major dislocation, exemplified by Kenya's sale last week and Guatemala's new issuance.

Alibaba's widely-reported but unconfirmed interest in a sizeable Hong Kong secondary listing is structurally interesting. Its initial NYSE flotation in part reflected the Hong Kong Exchange's restrictive policy towards companies with unconventional share and control structures. In 2018, Hong Kong eased such limitations for the technology sector - for example permitting dual-voting structures favoring a company's founders and early investors - seeking to recapture global market share and attract new high-tech flotations from the Chinese market. Successful completion of a large-scale Alibaba share sale - if this happens - would reinforce such ambitions.

Irrespective of local debate over the exact debt configuration of both Guatemala and Dominican Republic, both are widely viewed as having relatively favorable debt sustainability indicators by regional standards. However, given sizeable informal economies and political risk factors, they are rated in the sub-investment grade category, with S+P attributing a BB- level to both states. As such, their ability to complete debt sales given prevailing uncertainties will be a risk-positive indicator of market resilience.

Posted 31 May 2019 by Brian Lawson, Senior Economic and Financial Consultant, Country Risk, IHS Markit

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