Natalia Gurushina, Chief Economist, Emerging Markets Fixed Income Strategy
July 30, 2020
The U.S. Federal Reserve extended emergency swap lines, providing an important backstop for EM. Turkey’s international reserves predicament worsens.
The U.S. Federal Reserve (Fed) confirmed its dovish stance, so we can move on. From the emerging markets (EM) perspective, one much-appreciated policy gesture was the extension of the Fed’s emergency swap lines until March 2021. Regarding the level of international reserves, EM in general (important details in the next bullet point) are in a better position this time around compared to the previous crises. Many of them explicitly target reserves and use currencies as “escape valves” to deal with exogenous shocks. This approach opened up space to cut policy rates and support growth. So, in a sense, EM are helping themselves by conducting orthodox policies, but the Fed’s swap lines are considered an important backstop that helps EM to weather this storm.
Our key message is that EM should not be treated as a monolith. So, even though EM international reserves did not fall as much during the COVID episode and bounced back quickly, there are important differences—which become even more apparent if we look at reserves relative to M21 money supply (see chart below). This metric is part of the standard reserve adequacy assessment, and it shows why the market is so worried about Turkey. The only country that scores worse than Turkey is China. However, China can afford to have a very low Reserves/M2 ratio because of strict and credible capital controls—and this invites questions whether Turkey will be forced to do the same.
Mexico’s Q2 real GDP collapse was record-setting (-17.3% quarter-on-quarter) albeit not completely unexpected. The currency was not particularly thrilled though, trading 115bps weaker against U.S. dollar by mid-morning (as of 10:20am ET, according to Bloomberg LP). The release supports the market expectation of additional rate cuts (around 100bps in the next 12 months). Still, the growth rebound is expected to be very gradual, given the government’s refusal to open up fiscal spigots.
Chart at a Glance: EM Reserves – Turkey In Spotlight
Source: VanEck Research, Bloomberg LP
1M2 is a calculation of the money supply that includes all elements of M1 as well as "near money." M1 includes cash and checking deposits, while near money refers to savings deposits, money market securities, mutual funds, and other time deposits. These assets are less liquid than M1 and not as suitable as exchange mediums, but they can be quickly converted into cash or checking deposits.
IMPORTANT DEFINITIONS & DISCLOSURES
PMI – Purchasing Managers’ Index: economic indicators derived from monthly surveys of private sector companies; ISM – Institute for Supply Management PMI: ISM releases an index based on more than 400 purchasing and supply managers surveys; both in the manufacturing and non-manufacturing industries; CPI – Consumer Price Index: an index of the variation in prices paid by typical consumers for retail goods and other items; PPI – Producer Price Index: a family of indexes that measures the average change in selling prices received by domestic producers of goods and services over time; PCE inflation – Personal Consumption Expenditures Price Index: one measure of U.S. inflation, tracking the change in prices of goods and services purchased by consumers throughout the economy; MSCI – Morgan Stanley Capital International: an American provider of equity, fixed income, hedge fund stock market indexes, and equity portfolio analysis tools; VIX – CBOE Volatility Index: an index created by the Chicago Board Options Exchange (CBOE), which shows the market's expectation of 30-day volatility. It is constructed using the implied volatilities on S&P 500 index options.; GBI-EM – JP Morgan’s Government Bond Index – Emerging Markets: comprehensive emerging market debt benchmarks that track local currency bonds issued by Emerging market governments.; EMBI – JP Morgan’s Emerging Market Bond Index: JP Morgan's index of dollar-denominated sovereign bonds issued by a selection of emerging market countries; EMBIG - JP Morgan’s Emerging Market Bond Index Global: tracks total returns for traded external debt instruments in emerging markets.
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