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We’re Gonna Need a Bigger Boat?

March 15, 2023

Read Time 2 MIN

Global recession concerns are back with the vengeance. Can China’s rebound offset risks stemming from DM banking troubles?

Recession Fears and Fed Rates

Concerns that the Silicon Valley Bank and Credit Suisse “episodes” might not be isolated cases, but rather precursors to a fully-blown banking crisis and a global recession, are not going away, keeping the market expectations for the U.S. Federal Reserve (Fed) thoroughly depressed. The remaining Fed hikes are pretty much out the window this morning, and the Fed Funds Futures now price in 115-120bps of rate cuts (!) between now and December. The European Central Bank’s (ECB’s) rate-setting meeting is tomorrow – policy messaging has been quite hawkish until recently (given a series of upside inflation surprises), but the rate hike expectations are also dwindling as banking concerns jumped from the U.S. to Europe.

China Rebound

One counter-point to the global recession narrative is China’s reopening and growth rebound. The latest domestic activity indicators confirmed that even though the recovery is still moderate, it is gaining pace across the board (an encouraging sign for those concerned about China’s unbalanced growth). Importantly, property investments are finally started to show signs of stabilization – a signal that the easing of housing restrictions is bearing fruit. There was nothing to suggest that the economy needs another massive stimulus, but certain sectors and smaller privately-owned companies might require continuing targeted support.

EM Reaction to Market Turbulence

Many emerging markets (EM) are expected to benefit from China’s improving growth outlook – especially in Asia – but the market turbulence in developed markets (DM) is a major risk. So far, the reaction of EM sovereign bonds was quite logical (see chart below). Investment Grade bonds held on quite well (despite thinner spread “cushions”), while spread returns on lower-rated bonds were dragged down, in part, by higher U.S. rates’ volatility. EM FX is under more pressure today, but many local rates rallied in tandem with U.S. Treasuries. A sign of EM resilience so far is that the market continues to price in orderly (and cautious) rate cuts by those central banks that hiked early and aggressively in response to the rising post-pandemic price pressures – rather than “emergency” rate hikes to stem depreciation pressures, as was often the case in the past. Stay tuned!

Chart at a Glance: Market Turbulence and EM Sovereign Bonds – Logical Reaction

Chart at a Glance: Market Turbulence and EM Sovereign Bonds - Logical Reaction

Source: Bloomberg LP. Data from 3/9/2023 to 3/14/2023.

PMI – Purchasing Managers’ Index: economic indicators derived from monthly surveys of private sector companies. A reading above 50 indicates expansion, and a reading below 50 indicates contraction; ISM – Institute for Supply Management PMI: ISM releases an index based on more than 400 purchasing and supply managers surveys; both in the manufacturing and non-manufacturing industries; CPI – Consumer Price Index: an index of the variation in prices paid by typical consumers for retail goods and other items; PPI – Producer Price Index: a family of indexes that measures the average change in selling prices received by domestic producers of goods and services over time; PCE inflation – Personal Consumption Expenditures Price Index: one measure of U.S. inflation, tracking the change in prices of goods and services purchased by consumers throughout the economy; MSCI – Morgan Stanley Capital International: an American provider of equity, fixed income, hedge fund stock market indexes, and equity portfolio analysis tools; VIX – CBOE Volatility Index: an index created by the Chicago Board Options Exchange (CBOE), which shows the market's expectation of 30-day volatility. It is constructed using the implied volatilities on S&P 500 index options.; GBI-EM – JP Morgan’s Government Bond Index – Emerging Markets: comprehensive emerging market debt benchmarks that track local currency bonds issued by Emerging market governments; EMBI – JP Morgan’s Emerging Market Bond Index: JP Morgan's index of dollar-denominated sovereign bonds issued by a selection of emerging market countries; EMBIG - JP Morgan’s Emerging Market Bond Index Global: tracks total returns for traded external debt instruments in emerging markets.

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