Quotable

“Time cools, time clarifies; no mood can be maintained quite unaltered through the course of hours.”

--Thomas Mann

Commentary & Analysis

Emerging Market Bonds: The Canary in the Coal Mine?

We know there has been a massive stretch for yield among global investors. The emerging market (EM) bonds has benefited from this phenomenon. 

But you may not know US dollar credit to non-banks outside the United States has soared since the credit crisis of 2007-08; nowhere more has it risen than in the EMs:

US dollar credit to non-banks outside the United States

Source: BIS – Global dollar credit: links to US monetary policy and leverage

Yes. That chart above reads: $6 trillion dollars in US dollar credit attributed to EMs—it’s an approximate doubling since the credit crisis. This is scary to me. It is rocket fuel for global market volatility, to say the least. 

Think of the pressure now on many emerging market economies where all this debt resides:

1)      Rising cost of dollar denominated debt as the US dollar appreciates

2)      Stagnant global demand for the stuff emerging markets make and export

3)      Increasing deflationary pressure being pumped out by China final goods exports

4)      Increasing export competitive price pressures (from China)

I suspect the big money investors into emerging market bonds were well aware of stagnant global demand; and, to a degree, expectations for a rising dollar. But I doubt many expected to see the Chinese currency heading due south against the US dollar (for years there was a belief the Chinese currency was dramatically undervalued). But reality trumped expectations once again, and that reality ramping up the financial and economic pressure on EMs as defined in #3 & #4 above. 

The interesting thing, or scary thing, is this: Even though the Chinese currency has been tanking in value, both EM bonds and stocks have been rising. 

Up until last April there was a semblance of correlation, i.e. a weaker Chinese currency equals stronger EM bonds and stocks. That changed dramatically in April. Since then, a large divergence has developed between China’s yuan value and that of EM bonds and stocks, as I hope you can see in the chart below: