Contents
Market Overview
Macro Review
Powell states that “substantial further progress” has been met for inflation and largely for employment. The frenzy of hawkish Fed speakers continued, although the message from Bostic, Bullard, Harker, George and Kaplan was consistent with previous remarks, although Powell seems onboard to begin tapering by year-end. This adds some pressure on Clarida, Brainard and Williams as we have yet to see any significant moderation in their dovish positions. The pressure will only grow if the next NFP is as strong as the June/July readings. In the aftermath of Chair Powell’s speech, the dollar weakened 0.4%, equities spiked 0.6-1.0% and U.S. Treasuries tightened 2-3bp. The bullish impetus saw the S&P 500 reach its 51st daily all-time high in 2021 (>4,500). Elsewhere this week, South Korea became the first Asian central bank to hike rates, while Hungary became the first EM central bank to taper its asset purchases (aggregated asset purchases reflect 5.4% of GDP). Other notable events saw Turkish stocks generate the best monthly return of the year, crude oil had its best weekly gain since May 2020, while the Brazilian real had its best one-day performance since January. In Africa, we saw Nigerian GDP gain at its fastest pace in seven years, while South Africa’s unemployment came in at 34.4%, reflecting the highest reading on record (albeit data only extends to 2008). The broader theme of China’s regulatory crackdown continues, although the market was more upbeat with a slew of earnings from the property sector that exceeded expectations.
EM Credit Update
EM Sovereign Credit ended the week up +0.2% with spreads 9bp tighter as U.S. Treasuries widened 6-8bp. Outperformers on the week include Sri Lanka, Argentina and Ghana, while Belize, Tunisia and Suriname lagged.
The Week Ahead
Markets will continue to digest Powell’s Jackson Hole remarks over the weekend, partly as the calendar remains light into Labor Day. Nevertheless, there is a growing likelihood of a weaker manufacturing PMI miss in China, given that 17 provinces were affected by the delta variant. Consensus is pinned at 50.1 after 50.4 previously. Besides Hong Kong retail sales, Chile is the only major EM central bank with an interest rate decision, where Banxico’s 2Q21 report is likely to make a headline. Elsewhere there are inflation releases out of Indonesia, Turkey, Poland and South Korea. This will be complemented by a slew of GDP releases from Brazil, Czech Republic, India, Poland and Turkey.
Highlights from emerging markets discussed below include: New Special Drawing Rights allocation at the IMF alleviates fiscal and external funding pressures across emerging markets; Sri Lanka’s government reportedly warms-up to the possibility of deeper engagement with the IMF, amid external funding pressures and delayed economic recovery; and Global emerging market corporates in focus: What does ‘support’ look like?
Fixed Income
Equities
Commodities
Source for data tables: Bloomberg, JPMorgan, Gramercy. EM Fixed Income is represented by the following JPMorgan Indicies: EMBI Global, GBI-EM Global Diversified, CEMBI Broad Diversified and CEMBI Broad High Yield. DM Fixed Income is represented by the JPMorgan JULI Total Return Index and Domestic High Yield Index. Fixed Income, Equity and Commodity data is as of August 27, 2021 (mid-afternoon).
Emerging Markets Weekly Highlights
New Special Drawing Rights allocation at the IMF alleviates fiscal and external funding pressures across emerging markets
Event: This week, IMF member countries received their respective share from newly allocated Special Drawing Rights (SDR) worth $650bn. Emerging market (EM) economies with outstanding sovereign debt account for around $225bn, while developed market (DM) countries will absorb the bulk of the remaining $425bn.
Gramercy Commentary: There have been discussions over some sort of “redistribution scheme” for the new SDRs from DM to EM to provide additional financial relief where it is needed most amid the coronavirus crisis, but with limited progress thus far. In any case, the $225bn allocated to EM IMF members with market debt is a credit positive event that will provide welcome liquidity relief for a number of sovereigns across emerging markets. Importantly, the IMF has left it up to national authorities to decide if the SDRs would be channeled to support their external (i.e. FX reserves) or fiscal accounts (i.e. budget financing), allowing the funds to be used to meet the most pressing needs for each member government. As a reminder, SDRs are an international reserve asset and its value is based on a basket of five currencies: the U.S. dollar, the euro, the Chinese renminbi, the Japanese yen, and the British pound sterling. It can be easily exchanged for hard currency with another central bank of an IMF member state at a low interest rate (<1% per annum), which allows on demand timely access to freely usable hard currency. From that perspective, SDRs would be most impactful to economies that face high costs to borrow externally and/or balance of payments pressures. A few examples of sovereign borrowers for which the new SDR allocation is most sizable relative to their existing foreign currency reserves include: Zambia, Suriname, Sri Lanka, Ecuador, Jamaica, Bahrain, Belarus, and Argentina, among others.
Sri Lanka’s government reportedly warms-up to the possibility of deeper engagement with the IMF, amid external funding pressures and delayed economic recovery
Event: Speculations in local media that the authorities are re-visiting a potential engagement with the IMF, including a formal funded program, have intensified this week, supporting bond prices.
Gramercy Commentary: As we have written previously, the appointment in July of Basil Rajapaksa, younger brother of President Gota Rajapaksa and Prime Minister Mahinda Rajapaksa, as Finance Minister, has probably improved the odds of re-engagement with the IMF over the medium-term (1yr+). This being said, we continue to think that a muddle-through scenario supported by ad-hoc external financing is the most likely scenario in the short-run (by YE21). For the time being, the authorities seem to remain reluctant to commit to the reform conditionality that will be required under an official Fund program. As such, we think re-engagement with the IMF over a program needs some more time and internal political maneuvering, but the probability will likely increase from early 2022 as external financing and balance of payments pressures persist amid a delayed domestic economic and tourism recovery. The $0.8bn from the new SDR allocation received this week and other expected bi-lateral funding in the near-term relieves some immediate pressures, but will not be sufficient in the context of large, medium-term external obligations. We maintain our strong conviction that the Sri Lankan authorities’ willingness to service external debt obligations remains extremely high, which will eventually incentivize the government to re-open negotiations with the IMF over the reforms necessary for a program. We expect the market to welcome such a development, with actual recovery values subject to the modalities of IMF’s debt sustainability analysis, the government’s willingness to commit to a fiscal adjustment and the economy’s medium-term outlook.
Global emerging market corporates in focus: What does ‘support’ look like?
Event: Earlier in August, it was announced that five government-related entities would subscribe to newly-issued shares to be issued by China Huarong Asset Management Company (CHAMC). This would “replenish the Company’s capital, further consolidate the Company’s foundation for sustainable operations and ensure the Company meets regulatory requirements”. This is currently a non-legally binding framework agreement. The announcement came many months after CHAMC disclosed that the publication of results for 2020 would be delayed. Developments at CHAMC have, once again, raised questions about the many shades, shapes and sizes of support.
Gramercy Commentary: When it comes to state support, words can sometimes be enough. A timely ”whatever it takes” from a central banker or other authoritative figure can help quell market concerns significantly. However, verbal intervention often needs to be accompanied by action. This may come directly from the state or, as in the case of CHAMC, indirectly. As is well known, support can take a myriad forms – from ‘plain vanilla’ cash injections and explicit guarantees to complex, non-cash capital infusions, purchases of assets, assumption of liabilities, regulatory forbearance and much more. The state may disclose this support to the market at the time it is extended, or it may only become public long after the fact. The extension of below-market funding to VEB was one example of the latter. In deciding whether or not to extend support, authorities often thread the fine line between avoiding moral hazard and avoiding sector and/or system contagion. This can mean that support is delayed, and may mean rating agencies reassess their views on similar or related issuers, as with Moody’s and three of China’s asset management companies. Other considerations include the perceived impact of walking away on certain parts of the population (as with African Bank, where there was little overlap between its clients and those of the largest South African lenders). In addition, state intervention has clearly had varied and disparate implications for creditors based not just on the ranking of instruments held, but also on tenor, size, currency and the nature of the holder base. Importantly, motivations and other factors can vary over time. This means that historic support may not guarantee future help. We are seeing some economies move away from providing overt support without cost to bondholders and moving towards market-based solutions. For financial institutions in particular, this partly reflects increased issuance of loss-absorbing instruments and the evolution of workout frameworks (resolution regimes). While these frameworks may be more commonplace in developed markets, some emerging economies also have resolution regimes in place. We are also seeing measures such as total loss-absorbing capacity discussed, most recently in Mexico. Taken together, this all means that state support is continuously evolving and assumptions regarding bondholder-friendly support should not replace in-depth credit analysis.
Emerging Markets Technicals
Emerging Markets Flows
Source for graphs: Bloomberg, JPMorgan, Gramercy. As of August 27, 2021.
COVID Resources
Emerging Markets COVID-19 Case Summary
Source: Worldometer as of August 27, 2021.
Additional Crisis Resources:
Johns Hopkins COVID-19 Case Tracker
For questions, please contact:
Kathryn Exum, Senior Vice President, Sovereign Research Analyst, [email protected]
Petar Atanasov, Senior Vice President, Sovereign Research Analyst, [email protected]
Tolu Alamutu, CFA, Senior Vice President, Corporate Research Analyst, [email protected]
James Barry, Vice President, Corporate Research Analyst, [email protected]
This document is for informational purposes only. The information presented is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. Gramercy may have current investment positions in the securities or sovereigns mentioned above. The information and opinions contained in this paper are as of the date of initial publication, derived from proprietary and nonproprietary sources deemed by Gramercy to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. This paper may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this paper is at the sole discretion of the reader. You should not rely on this presentation as the basis upon which to make an investment decision. Investment involves risk. There can be no assurance that investment objectives will be achieved. Investors must be prepared to bear the risk of a total loss of their investment. These risks are often heightened for investments in emerging/developing markets or smaller capital markets. International investing involves risks, including risks related to foreign currency, limited liquidity, less government regulation, and the possibility of substantial volatility due to adverse political, economic or other developments. The information provided herein is neither tax nor legal advice. Investors should speak to their tax professional for specific information regarding their tax situation.