HONG KONG, April 20 (Reuters) - Global investors are turning more cautious over the outlook for emerging market sovereign bonds, faced with rich valuations and increasing supply from countries struggling with slowing growth.
Developing nations have rushed to borrow billions of dollars in cheap funds as the U.S. Federal Reserve and other central banks launched aggressive bond buying programmes that have lowered long-term rates and pushed investors into riskier but high-yielding assets.
"The extent of the recent rally that has occurred across all emerging market asset classes is starting to look a little stretched in the short term," said Richard House, global head of emerging market debt at Standard Life Investments which manages $79 billion in fixed income. "This is occurring at a time when sovereign issuance is about to increase significantly."
Adding to record supplies in recent weeks is Argentina, a junk-rated issuer, hoping to raise up to $15 billion, its first such sale since its 2001 default.
The Latin American country is not alone. The first quarter of 2016 has been prolific for emerging market sovereign issuers with countries and quasi-sovereign names selling $44 billion of debt, the highest in more than 15 years, according to Thomson Reuters data.
The mountain of debt prevails in spite of economic warnings. The International Monetary Fund cut its outlook for the world economy for the fourth time last week, citing the poor quality of emerging market growth as risk factors, among others.
Some investors believe the hunger for high-yielding emerging market debt has been buoyed by favourable factors such as loose monetary policies rather than careful analysis of credit risks, and the threshold for risk taking is still high.
By the close of business in New York on Monday, IFR reported that Argentina's four tranche transaction attracted a book of more than $65 billion. The price range is expected to be higher than initial estimates, a sign of robust demand.
"Global factors such as a dovish Fed, declining term premia and tightening credit spreads are driving emerging market asset outperformance making it harder to access specific risks," said Bryan Carter, head of emerging market fixed income at BNP Paribas Investment Partners, whose team manages $1.2 billion in funds.
A yield on the JP Morgan global index measuring sovereign credit performance has fallen to 6 percent, far below its 15-year average of 7.4 percent.
But the average duration of debt held by the index has risen to roughly eight years from around five in 2010, according to Thomson Reuters data indicating that fund managers are forced to go farther down the curve even as yields ratchet lower.
Market watchers believe easy credit conditions are gradually reversing as banks grow more cautious about lending funds amid slowing growth due to concerns of defaults.
Deutsche Bank strategists say the growth of excessive poor-quality debt, flattening yield curves and rising episodes of market volatility indicate defaults will likely rise.
Political risks in Latin America and China's debt bubble are also worrisome. Total debt as a percentage of GDP in the world's second-largest economy has ballooned to nearly 300 percent since 2007.
"The China credit boom is the biggest credit boom the world has ever seen," said House, of Standard Life Investments. "A slowing economy with a large corporate debt overhang is not an attractive prospect."
Though Asian bonds have outperformed their emerging market peers since February, traders say much of the outperformance has been due to technical factors such as cashed-up investors chasing yields amid shrinking supply of offshore Chinese debt.
"Broadly speaking, fundamentals are not positive for emerging markets," said Elizabeth Allen, head of credit research at HSBC global asset management which manages $63 billion in assets.
The risk for countries raising dollar-denominated debt is that rising U.S. rates and a stronger greenback will make debt repayments more expensive, leading to more defaults.
Editing by Jacqueline Wong