Emerging Markets Debt Daily
Contagion – The Good, the Bad, and …?Natalia Gurushina, Chief Economist, Emerging Markets Fixed Income StrategySeptember 16, 2021
The Evergrande saga continues to weigh on market sentiment. Would the Fed mention China in its policy comments when it meets next week amidst China contagion risks?
Today’s comments and newswires reports are peppered with the word “contagion”. Contagion is usually a scary notion, but not all of it is bad – such as orthodox policy “contagion” in emerging markets (EM). In its current reincarnation, “good” policy contagion means that EM central banks are tightening/normalizing because they respond to higher inflation pressures within their inflation-targeting mandates and they believe these pressures are not transitionary or one-offs. The latest inflation and domestic activity releases in EM signal that more “good” contagion is coming in the form of rate hikes in Brazil, the Czech Republic, and Colombia. Some central banks are trying to buck the trend – specifically Poland and Turkey. Poland should come to its senses eventually – especially if headline inflation breaches 6% year-on-year in the coming months. Turkey, unfortunately, is a more complicated case, with President Erdogan once again promising to tame inflation as soon as possible. But, as we said, these are exceptions that prove the rule.
“Bad” contagion refers to today’s risk-off sentiment following additional unsettling headlines about the Evergrande saga (as well as more regulations in China’s tech sector (video games)). A big concern right now is that these developments will further worsen China’s near-term growth outlook, given the large share of mortgages in household debt and the major increase in household debt as a percentage of GDP in the past few years. China’s status as a major global growth engine can add to downside growth risks in parts of EM. Especially in EMs which are tightening financial conditions (the major developed markets (DM) are seeing nothing but easy financial conditions - see chart below).
“Ugly” contagion would be the Evergrande story creating financial instability and spilling over to global markets (and/or having a wider economic impact inside China). This is not a baseline scenario for most observers, but one thing we’d like to mention is that there were several occasions in the past when the U.S. Federal Reserve (Fed) mentioned China in its reaction function comments. This may be harder for the Fed to acknowledge going forward, given geopolitical tensions, but it’s something to keep an eye on as the Fed meets next week amidst China contagion risks.
Chart at a Glance: Financial Conditions in EM Tightening Faster than in DM
PMI – Purchasing Managers’ Index: economic indicators derived from monthly surveys of private sector companies. A reading above 50 indicates expansion, and a reading below 50 indicates contraction; 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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