(Bloomberg) -- The cost of insuring emerging-market nations against default fell to the lowest in nearly a year as the dollar weakens and investors bet that less aggressive US tightening will bring relief to developing borrowers.

Investors took heart from Federal Reserve Chair Jerome Powell’s comments this week that while more US interest-rate increases are on the cards, disinflationary pressures are already materializing. The cost of hedging against a default by 18 emerging economies from China to Panama declined to 211 basis points on Friday, according to IHS Markit data, the least since before Russia invaded Ukraine last February.

The cost of insuring against default peaked last July as surging inflation forced the world’s major central banks to abruptly end the easy-money era, which had allowed emerging markets to borrow at record-low rates. The global decline of the dollar is helping to further ease concerns over how emerging-market countries will repay their international bonds.

“Borrowers are seeing light at the end of the tunnel given that many G-10 and EM central banks are getting closer to terminal rates,” said Mitul Kotecha, head of emerging-markets strategy at TD Securities in Singapore. “The weaker dollar is providing a major buffer.”

The average yield on dollar bonds sold by emerging-market sovereigns has fallen 181 basis points since October to 7.58%, according to a Bloomberg index. Still, it’s 223 basis points higher than a year ago.

Distressed Debt

Around mid-2022, the International Monetary Fund also became more active in supporting distressed nations amid broader contagion fears. The Markit risk gauge consists of some of the fastest growing emerging economies like the Philippines, Saudi Arabia, South Africa and Latin American giants including Brazil. It doesn’t include any of the debt-distressed countries, like Ghana or Pakistan. 

“The direction of the dollar, how long and how much the Fed will tighten, and the outlook for global growth will have a much stronger influence on the large emerging markets than a few defaults or crises in smaller frontier countries,” said Nick Stadtmiller, director of emerging markets at Medley Global Advisors in New York. 

The global economy should avoid a hard landing for credit perceptions to improve further, said Witold Bahrke, a senior macro strategist at Nordea Investment Management AB in Copenhagen. He favors emerging nations with “good reform momentum and fiscal prudence,” such as Egypt, Angola and Indonesia.

“First, global monetary conditions should not tighten further from here,” he said. “Secondly, a severe recession in the US and euro area should be avoided. Needless to say, neither of this is part of our base case.”

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