Keith Collister

Jamaica's Eurobond prices collapsed last week in unusually volatile trading with some issues falling by as much as 15 per cent due to the perfect storm of an international banking panic, the general sell-off in emerging market debt, international short sellers selling Jamaican bonds they didn't own in the hope of profiting by buying them back at lower prices, and a lack of local US dollar liquidity for the local players to buy Jamaica's bonds that had been accentuated by margin calls (demand for repayment of the money lent by Wall Street locally to buy bonds) created by the same drop in the bond prices.

A good example of this volatility is the 2019 Jamaican Eurobond, which was issued only last June at just below par (meaning 100), traded between $78 - 83 at the height of the international banking panic last Friday, but by early Tuesday morning the bid offer spread had recovered sharply to 82-85.
Whilst it traded at around 90 to 91 by mid-Tuesday morning, according to Stocks and Securities Mark Croskery, it subsequently fell back in sympathy with the further falls in the US stock market on Tuesday and Wednesday.

In a speech to the Jamaica Manufacturers' Association a week ago Friday, Prime Minister Bruce Golding noted "When the crisis erupted on Wall Street three weeks ago with the collapse of Lehman Brothers, the authorities at the BOJ and FSC did an immediate assessment of local financial institutions to determine the extent of their exposure to the risk of contagion."

In a comment that probably signalled the Bank of Jamaica's Tuesday intervention, he noted: "In the event of margin calls on the few financial entities affected, the Central Bank was in a position to provide liquidity support."

Fisher believes that the Bank of Jamaica's temporary lending facility announced late Tuesday afternoon is very positive for our local bond market as it will help to reduce the pressure for the repayment of margin lent by Wall Street generated by the huge reduction in risk appetite caused by the falls in the US markets.

Emerging market debt remains under severe pressure

It is important to remember, however, that the fall in Jamaican bond prices over the past month is in no way unique to Jamaica, and is merely in line with the general collapse of emerging market debt. This climaxed last Friday after the one-week collapse in the US stock market, with sovereign bond issues with the same rating as Jamaica eg Venezuela falling between five per cent to eleven per cent last Friday morning, and heavy losses in the more highly rated sovereign bonds of Brazil, Colombia, Turkey, and Russia.

An analysis by JP Morgan (the bank that acquired Bear Stearns) notes that emerging market debt had been relatively unaffected by the turbulence in the developed markets until early September, when outflows from prime money market funds, pressure on commercial paper, and fears over counter-party risk contributed to a sharp sell-off in all emerging market debt. In addition to the price drops, liquidity dried up, which translated into the much wider bid/ask spreads seen for countries such as Jamaica.

According to Monday's Financial Times (FT), the market was pricing in the risk of default for countries such as Pakistan, Argentina, Ukraine, and Iceland at 80 per cent or higher as the banking systems of these countries came under increasing pressure due to the credit crisis.

The FT noted that "Trading in credit default swaps - a form of insurance against bonds' defaulting - indicates expectations that Pakistan has a 90 per cent chance of defaulting on its debt. CDS spreads on Pakistan, which is haemorrhaging foreign exchange reserves to prop up a weak rupee, have risen to a record 3,026 basis points, or a cost of more than $3m to insure $10m of debt over five years. This is a threefold jump since the collapse of Lehman Brothers on September 15."

The FT quoted Nick Chamie, head of emerging markets research at RBC Capital Markets, as follows: "Although I would not say any of these countries are likely to default in the coming weeks, there is certainly a higher risk. They are all suffering from the problems in the rich countries. They are the collateral damage of the western credit crisis. They benefited in the good times and now things have turned for the worse, these economies are under pressure."

The FT argues that continuing fears over credit risk in the emerging world is best illustrated by JP Morgan's sovereign emerging market bond index (EMBI), which has risen dramatically in the past month with developing world bond yields at their widest level over US Treasuries for five years.

Fortunately, according to a research piece by JP Morgan last week, these emerging market vulnerabilities are focused on the corporates instead of sovereigns, as emerging market public sector debt dynamics and financing needs are not at the root of the crisis.

Last Friday, many emerging market corporate bonds were simply not trading due to lack of liquidity, with some companies' bonds showing a spread of over 10 points. The rapid deterioration of the emerging market bank and corporate market, and ongoing losses in emerging market equities, means that current market dynamics are extremely unfavourable for those companies dependent on continued access to external credit.

For once, however, this situation is no different from that faced by the major industrialised countries. The major countries may finally be catching up, however, with the international banking panic at the root of the emerging market collapse after the new measures announced last weekend, when European governments pledged a total of euro1,873bn ($2,546bn) to shore up their financial sector.
The historic Monday rally, when the S&P 500 rose 11.6%, was due to the markets anticipating the US's own revised comprehensive rescue plan. This was finally announced on Tuesday morning, and committed $250bn out of the $700bn rescue package agreed by Congress earlier in the month to a recapitalisation programme for US banks in a similar fashion to the UK plan announced the previous week.

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