Contagion from China threatens to derail the world’s emerging markets

(Bloomberg) — A widespread sell-off in China is spilling over into emerging markets, threatening to stifle growth and drag down everything from stocks to currencies to bonds.

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New outbreaks of Covid-19 and the government’s strict policy to contain them are spooking global investors who fear the closures in China will reverberate around the world by lowering demand and disrupting supply chains. That pushes them to sell not only China’s currency, bonds and stocks, but also the assets of any developing nation that relies heavily on trade with the world’s second-largest economy.

The result is the steepest drop in emerging markets in two years, not unlike the crash in 2015 when China’s woes caused its bonds and currencies to plunge, as well as wipe $2 trillion from the value of stocks. Since then, the country’s influence in the world economy has only grown: it is now the largest buyer of raw materials, which means that its fall may affect commodity exporters and their markets more than ever.

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

As armies of white-suited enforcers descended on Shanghai and Beijing in late April to oversee mandatory testing of millions, the offshore yuan sank to its worst monthly loss in at least 12 years. The MSCI Emerging Markets Currency Index, with nearly 30% weighting for the Chinese currency, fell in tandem. The yuan’s 30-day correlation with the index rose to the strongest level since September, underscoring the currency’s influence in selling off emerging markets. After Shanghai reported its first deaths since the latest outbreak, panic selling spread to bonds and stocks.

Sudden drop in Chinese currency raises risk of a 2015-style panic

The scale of the losses prompted Chinese authorities to step in and reassure markets that they will support the economic recovery and boost infrastructure spending. They also noted a willingness to resolve regulatory issues in the technology sector. These promises calmed investors’ nerves even though the authorities did not abandon the harsh Covid Zero policy that had caused the panic in the first place. While the last trading day of April saw a rally in the yuan, most analysts expect the currency to resume its slide.

The offshore yuan fell 0.5% to 6.6726 per dollar at 6:43 a.m. in New York, extending a monthly decline that was the biggest in more than a decade. Local markets in China are closed for holidays.

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

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

Commodity Pain

The rand erased four months of gains in just two weeks, while the Brazilian real, Colombian peso and Chilean peso posted some of the steepest declines among their peers. Carry-trade losses soared, capping the worst performance since November.

Money managers moved quickly to downgrade their currency outlook for emerging markets. HSBC cut its forecast for nine Asian currencies, citing China’s economic woes. TD Securities and Neuberger Berman said the South Korean won and Taiwan dollar will come under further pressure.

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

Multi-Asset Route

Currency losses are also fueling a sell-off in local bonds, which sank in the worst first four months of a year on record, as April performance was the worst since the peak of the pandemic in March 2020 alone. Ballast here was China again. , with a 41% weighting in the Bloomberg index for the asset class. The nation’s bonds posted the biggest monthly decline since the 2008 financial crisis, while posting double-digit losses in countries as varied as South Africa, Poland and Chile.

Stocks weren’t spared either. A drop in Hong Kong-listed Chinese tech shares echoed half a world away in Johannesburg. Naspers Ltd., which owns 28.8% of Tencent Holdings, slumped to a five-year low. A three-week slump fueled in part by panic over China’s Covid cases, and in part by rising US yields, led emerging-market stocks to wipe out $2.7 trillion. in market value.

China’s economic activity contracted sharply in April as the Shanghai lockdown intensified concerns about further disruption to global supply chains. Factory activity fell to the lowest level in more than two years, and the official manufacturing PMI fell to 47.4 from 49.5 in March, according to data released by the Office for National Statistics on Saturday.

“China’s slowdown will compound the challenging outlook for emerging economies facing rising energy prices and tighter monetary policy from major central banks,” said Mansoor Mohi-uddin, chief economist at Bank of Singapore Ltd.

Xi’s promise to boost growth during lockdown met with skepticism

Here are the main things to watch in emerging markets in the coming week:

  • South Korea, Thailand and Taiwan are to release the latest inflation data for April, and March price growth rose to at least a near-decade high in all three economies.

  • 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.

  • Turkey’s inflation is forecast to rise to 65% in April, the highest since 2002, but is still unlikely to provoke a response from a politically restrained central bank.

  • In Brazil, the highlight of next week is the monetary policy meeting, where the yield curve shows that investors believe that the central bank will make good on its promise to raise the policy rate by 100 basis points.

  • In Chile, the central bank is likely to continue its tightening cycle at a more moderate pace and raise the benchmark interest rate to 8%.

(Updates with the fall of the offshore yuan in the seventh paragraph)

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