Welcome to the Great Emerging-Market Schism: A Virus-Made Split

(Bloomberg) --

A two-track world is starting to establish itself in emerging markets.

Not only are stocks, bonds and currencies of developing economies reacting to the Covid-19 pandemic in very different ways, but the fallout is quickly creating two distinct camps of winners and losers.

The growing dichotomy is starkest in the bond market, where the premium investors demand to hold riskier emerging-market debt has ballooned relative to the safer credits. In fact, the spread between these high-yield bonds and their investment-grade counterparts is now close to its widest since 2002, according to JPMorgan Chase & Co.’s indexes. Hence higher-rated borrowers such as Qatar, Abu Dhabi and Saudi Arabia accounted for more than a third of developing-nation Eurobond sales this month.

Welcome to the Great Emerging-Market Schism: A Virus-Made Split

Listen: EM Weekly Podcast: Oil Plunge; Lockdown Watch; Brazil Politics

“Emerging-market debt broadly reached its lows during March and will ever so slowly continue to recover from here,” said Paul Greer, a London-based money manager at Fidelity International, which manages about $380 billion. “In the near term, the best opportunity set -- with the greatest dollar total return potential -- is in emerging-market investment-grade-rated sovereign debt.”

The divergence underscores how the spread of the virus and the differing ways in which governments are responding -- both through lockdowns and stimulus efforts -- are making many investors leery of putting their money into anything but the strongest assets. Emerging markets clocked up a ninth week of outflows in the five days to April 17, but $1.4 billion flowed back into bonds, according to Credit Agricole SA.

The Philippines, an investment-grade nation, on Monday started marketing sovereign bonds denominated in dollars, joining a host of borrowers raising cash buffers to weather the coronavirus pandemic. The country is offering 10-year and 25-year tranches, people familiar with the matter said.

While the highest-rated bonds remain a surer bet for some investors, emerging-market currencies are likely to remain on the back foot as the clamor for the U.S. dollar persists. The gap between a JPMorgan gauge of expected volatility in developing-nation currencies over a similar Group-of-Seven measure has jumped to the highest since 2018.

“We do not think the necessary conditions are in place yet” for the dollar to weaken, Goldman Sachs Group Inc. strategists including New York-based Zach Pandl wrote in a note. “In our forecasts, the dollar begins to weaken around mid-year as a global economic recovery begins to take hold.”

Welcome to the Great Emerging-Market Schism: A Virus-Made Split

Weaker currencies may still provide a floor for stocks in many emerging markets. MSCI’s index of developing-nation equities has climbed 18% from a four-year low reached about a month ago.

More Easing, Potentially

  • The Bank of Japan on Monday removed limits on its purchases of government bonds, joining global counterparts in their unprecedented expansion of monetary stimulus
    • The U.S. Federal Reserve and European Central Bank will also convene for monetary-policy decisions this week after the pandemic-driven freezing of economies and turmoil in financial markets propelled them into action earlier
    • They may have to do even more to limit the recession and speed the recovery. Among the options: extending the quantitative easing, helping ease credit to troubled businesses and committing to rock-bottom rates for longer
    • Read: World’s Biggest Central Banks Meet as Pressure Mounts to Do More
  • Kazakhstan kept interest rates on hold following an emergency reduction earlier this month as the economy heads for its first contraction in more than two decades

    • The tenge has strengthened this month after slumping 15% in March as the economy of Central Asia’s largest energy producer feels the pain from a coronavirus lockdown and slump in oil prices
  • Colombia’s central bank is expected to reduce its key lending rate by another 50 basis points to 3.25% on Thursday, which would be the lowest since 2014. Policy makers looking for ways to combat the economic toll of the pandemic have already cut interest rates by 50 basis points this year
  • Kenya will probably look past the shilling’s weakness over the past month and lower rates on Wednesday, according to economists’ forecasts. Botswana will decide on policy a day later
  • Hungary’s central bank is set to keep borrowing costs on hold on Tuesday, ahead of planned asset purchases starting in May
    • The forint has weakened against the euro since mid-April

Latam Drama

  • Brazilian markets are nervous as President Jair Bolsonaro’s anti-graft credentials were thrown into doubt after Sergio Moro abruptly resigned as justice minister. Sovereign bonds extended declines on Monday, after stocks fell as much as 9.6% on Friday and the currency reached an all-time low
    • Authorities will release inflation figures for the first part of April on Tuesday. They will probably show a decline from a year ago, according to economists surveyed by Bloomberg. The nation will also post its March primary budget balance on Thursday. The real has underperformed all of its emerging-market currency peers so far this year
    • “While the president does not appear to be trying to undermine Economy Minister Paulo Guedes, the prospect of a big political crisis in the middle of a pandemic has driven a downgrade of the country’s short- and long-term political trajectories,” Eurasia Group said in a note
    • Read: Bolsonaro Bet Big With Two Promises And Both Are In Trouble
  • Investors will be watching for signs of a sweeter debt-restructuring deal from Argentina. The government and the province of Buenos Aires will start setting up virtual meetings this week with institutional investors
    • The government is proposing a three-year moratorium on payments, a 62% cut to coupons and an across-the-board delay to maturities. A gauge of economic activity for February will be published on Tuesday

Economic Data

  • China releases April purchasing managers’ indexes for manufacturing, and services and construction on Thursday. Economists predict manufacturing activity sustained its rebound from March, though the outlook is uncertain with many economies around the world still in lockdown
    • An improvement might further help the yuan, which has been one of the few emerging-market currencies to gain against the dollar this month
  • Taiwan reports preliminary gross domestic product for the first quarter on Thursday
    • The economy probably expanded 1% from a year ago, slowing from 3.3% in the previous three months, according to Citigroup Inc., citing social distancing measures, travel restrictions and regional supply-chain disruptions
  • Thailand releases trade, current-account, and reserves figures on Thursday; the baht, which has rebounded this month, may be further boosted if the data are positive
    • The government extended its state of emergency by a month to May 31 to cement progress in reducing novel coronavirus infections
  • South Korea reports March industrial-production data on Wednesday and April trade figures on Friday. The slide in exports is expected to worsen, putting pressure on an economy that contracted the most since the global financial crisis last quarter
    • South Korea’s exports -- a bellwether of global trade trends -- probably slumped in April, reflecting weakening demand due to lockdowns in the U.S. and Europe, according to Bloomberg Economics
  • Mexico will release preliminary first-quarter gross domestic product figures on Thursday that may reflect some early impact of Covid-19 on growth
  • Chile’s copper production numbers for March are due on Thursday, and investors will watch for signs of slower demand amid the virus. The country’s sturdy fiscal footing and virus response has allowed one of its bonds to hang on as the last dollar-denominated government note in Latin America with positive returns this year
  • Zambia and Kenya release April inflation data on Thursday. Both countries’ currencies have come under pressure in the past month and any acceleration in inflation may worsen that trend
  • Turkey’s central bank will hold a virtual inflation report briefing on Thursday. Policy makers lowered interest rates more than forecast by most economists last week, forcing state banks to defend the lira to keep it from breaching the 7-per-dollar mark

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