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China infection threatens to derail the world’s new markets

Widespread sales in China are rippling through emerging markets, threatening to halt growth and pull everything from equities to currencies and bonds down.

Recent Covid outbreaks – and the government’s stringent policy to curb them – scare global investors, fearing that shutdowns in China will resonate around the world by lowering demand and disrupting supply chains. It pushes them to sell not only China’s currency, bonds and shares, but the assets of any developing nation that is heavily dependent on trading in the world’s second largest economy.

The result is the sharpest drop in emerging markets in two years, not unlike the meltdown in 2015, when China’s suffering led to a downturn in their bonds and currencies, in addition to wiping out $ 2 trillion from stock values. Since then, the country’s influence on the global economy has only grown: it is now the largest buyer of commodities, meaning its crisis could affect commodity exporters and their markets more than ever.

“Given China’s importance in global supply chains and its importance for global growth prospects, further disappointments in the nation’s growth could lead to more contagion risk,” Johnny Chen and Clifford Lau, money managers at William Blair Investment Management in Singapore, wrote in an email. “We see countries with high trade ties to China as the most vulnerable.”

As armies of white-collar enforcers marched down to Shanghai and Beijing in late April to oversee the mandatory test of millions, the offshore yuan sank to the worst monthly loss in at least 12 years. The MSCI Emerging Markets Currency Index, with a weight of almost 30% for the Chinese currency, collapsed in parallel. The yuan’s 30-day correlation to the index rose to its strongest level since September, underscoring the currency’s impact on emerging market sales. After Shanghai reported its first deaths since the recent outbreak, panic selling spread to bonds and equities.

The magnitude of the losses prompted the Chinese authorities to step in and reassure the markets that they would support the economic recovery and increase infrastructure spending. They also signaled a willingness to solve regulatory problems in the technology sector. These promises reassured investors’ nerves, even though the authorities did not abandon the strict Covid Zero policy that had triggered the panic in the first place. While the last trading day in April saw a recovery in the yuan, most analysts expect the currency to resume its decline.

The offshore yuan fell 0.6% to $ 6.6827 per dollar on Monday. China’s local markets are closed for a holiday.

Beijing’s 2022 growth target of 5.5% is now in doubt, prompting analysts from Standard Chartered Plc to HSBC Holdings Plc to predict currency losses over the next three months. It could, in turn, lower growth rates in countries such as South Africa and Brazil, just as they are also hit by higher US interest rates, an inflation spiral and the war in Ukraine.

“If China’s economy slows significantly, emerging market currencies as well as the yuan could experience a period of rising and sustained volatility,” said Brendan McKenna, a currency strategist at Wells Fargo Securities in New York.

Our pain

The rand erased four-month gains in just two weeks, while the Brazilian real, Colombian peso and Chilean peso had some of the sharpest declines among peers. Carry trade losses increased, covering the worst result since November.

Money managers moved quickly to downgrade their currency outlook for new markets. HSBC lowered its forecast for nine Asian currencies, citing China’s economic problems. TD Securities and Neuberger Berman said South Korea’s won and Taiwan’s dollars will come under greater pressure.

“We continue to maintain a cautious stance on Asian currencies and expect more volatility until some of these growth concerns subside,” said Prashant Singh, senior portfolio manager for emerging market debt at Neuberger Berman in Singapore.

Route with several assets

Currency losses also drive sales of local bonds, which fell to the worst first four months of a year ever, when performance in April alone was the worst since the peak of the pandemic in March 2020. The biggest problem here was China again. , with a weight of 41% in the Bloomberg asset class index. The nation’s bonds showed the largest monthly decline since the financial crisis in 2008, triggering double-digit losses in countries as diverse as South Africa, Poland and Chile.

No shares were saved. A route in Chinese technology stocks listed in Hong Kong resonated half the world away in Johannesburg. Naspers, which owns 28.8% of Tencent Holdings, fell to a five-year low. A three-week recession, partly driven by panic over Covid cases in China (and partly by rising US interest rates) caused shares to erase $ 2.7 trillion in market value.

China’s economic activity fell sharply in April as the shutdown of Shanghai escalated concerns about further disruptions in global supply chains. Factory activity fell to its lowest level in more than two years, with the official PMI for manufacturing falling to 47.4 from 49.5 in March, according to data released by the National Bureau of Statistics on Saturday.

“China’s downturn will exacerbate the challenging outlook for emerging economies facing skyrocketing energy prices and tighter monetary policy by major central banks,” said Mansoor Mohi-uddin, chief economist at the Bank of Singapore.

Here are the key things to look at in the emerging markets in the coming week:

South Korea, Thailand and Taiwan will release the latest inflation data for April, with inflation rising to at least a decade high in all three economies in March

  • Russia’s PMI survey will be one of the first glimpses of activity in April, the second full month of President Vladimir Putin’s war against Ukraine
  • Bond investors will be looking for coupon payments in dollars as the clock ticks for the country’s 30-day grace period, which ends May 4
  • Turkey’s inflation is set to rise to 65% in April, the highest since 2002, but it is still unlikely to trigger a response from a politically constrained central bank.
  • In Brazil, the highlight of the coming week is the monetary policy meeting, where the yield curve shows that investors believe that the central bank will live up to its promise to raise the key interest rate by 100 basis points.
  • In Chile, the central bank is likely to continue its tightening cycle at a more moderate pace, raising the benchmark rate to 8%

© 2022 Bloomberg

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