China Yield Slide, Not U.S. Surge, May Endanger Emerging Markets

(Bloomberg) -- While rising U.S. bond yields have triggered equity-investor anxiety around the world this year, when it comes to emerging markets, it’s the slide in China’s yields that may be posing the greater danger.

Yields on 10-year Chinese government bonds have been a strong indicator of earnings-per-share for emerging-market companies over the last five years, and the recent decline suggests a deteriorating outlook, Morgan Stanley strategists including Graham Secker and Jonathan Garner wrote in a note to clients Friday.

“What makes the move more disconcerting is that there has been a very close correlation between China yields and the global economic surprise index over the last year,” the strategists wrote. “This raises the question as to whether China is the potential source of slowing economic momentum through the global economy.”

The concern showcases the increasing importance of China as a lodestar for developing economies, compared with the U.S. For decades, a key concern for emerging markets was how they would cope with rising American interest rates, and the shifts in capital flows that often accompanied them. Now, it’s a softening in China that could pose the key risk.

China’s 10-year government bond yields have retreated to their lowest in almost a year, after the central bank’s unexpected move last week to ease funding pressure among lenders by cutting their reserve requirements. Even before that, the yields were coming down amid forecasts for China’s financial deleveraging initiative to damp growth this year

While U.S. yields have been climbing in response to expectations for further Federal Reserve interest-rate hikes as inflation pressures rise, China’s have come down alongside a softening in tone from global economic data. Citigroup Inc.’s Global Economic Surprise Index has fallen to its lowest in over two years.

Morgan Stanley cut its estimates for emerging-market earnings in a separate note earlier this month, and is now expecting growth of 10 percent in 2018 and 5 percent in 2019. That compares with consensus estimates of 23 percent and 11 percent respectively, according to data compiled by Bloomberg.

To contact the reporter on this story: Cormac Mullen in Tokyo at cmullen9@bloomberg.net.

To contact the editors responsible for this story: Christopher Anstey at canstey@bloomberg.net, Tomoko Yamazaki

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