Are EM credit spreads about to surge?

The yields of dollar-denominated emerging market government bonds have been broadly flat over the past month after having declined by over one percentage point between the end of January and the end of June. There has been a small increase in credit spreads over the past month, offset by a slight decline in underlying US Treasury yields.

We suspect that the yields of emerging market dollar-denominated government bonds will begin to rise soon, for two key reasons. The first is that we are forecasting US Treasury yields to rise. The second is that we think credit spreads will creep up as the Fed becomes less accommodative (and eventually tightens) and if volatility rebounds to more normal levels. That being said, we do not think that there is a bubble in emerging market government bonds that will burst soon and prompt a major sell-off. Spreads over US Treasuries of emerging market dollar-denominated government bonds still look quite high relative to spreads of comparably-rated US corporate bonds, despite the increase in US corporate spreads over the past month.