Jump in yields could spark central bank reaction
The recent jump in yields of emerging market debt caused by a rise in US Treasury yields could feed through into central bank reaction in the emerging world
Markets could see more second-round effects from the pressure coming from benchmark yields rising, but over the longer term there is still a case for investing in emerging market debt, according to Simon Quijano-Evans, head of emerging markets research at Commerzbank.
He pointed to "the better fundamentals backdrop" in emerging markets compared to developed ones and the "discovery" of emerging markets by investors who traditionally put their money into developed ones as factors that could buoy emerging markets again over a few months.
"In the meantime, the spillover from the jump in benchmark yields is likely to be emphasized by the added 'fears' of a stronger US dollar ahead, leading to the next stage of the reaction cycle, namely a pass-through into EM central bank policy," Quijano-Evans wrote in a weekly outlook note.
Until now, markets have generally positioned themselves for policy rate cuts in emerging markets and "while we won't get carried away just yet, EM central banks should be pleased with an eventual winding down of QE3 and a trending stronger US and USD story," he said. "This would allow them to return to a gradual normalization path with their monetary policy."
Monday's factory data from emerging markets show that, with the exception of Hungary and Poland, purchasing managers' indexes (PMIs) "have essentially converged on to the neutral 50 mark," he said.
Quijano-Evans said this probably suggests that the perception about the EU's ability to deal with the ongoing eurozone crisis has stabilized and that there are hopes in emerging markets that in spite of weaker domestic demand, the weakening trends for their currencies "should start to support the export story."
For analysts at Capital Economics, May's PMI signal a weakening of emerging market economies. This could mean that central bank rate hikes are unlikely any time soon in most emerging markets.
Their emerging markets PMI estimate compiled from data provided by Markit and aggregated according to each countrys weight in emerging markets' gross domestic product dropped below 50 for the first time this year, with much of the weakness concentrated in major countries.
"The pick-up in activity that began late last year has almost completely reversed," Mark Williams, chief Asia economist at Capital Economics, said.
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The Capital Economics EM PMI fell to 49.9 in May, from 50.7 in April.
"Historically, this reading has been consistent with emerging markets industrial production growth of around 4% year-on-year, well below the historical average," Williams said.
The most disappointing region from the point of view of manufacturing performance was emerging Asia, where, despite a wave of monetary policy loosening by central banks, the weakness was most pronounced.
India's PMI fell to 50.1 last month, the worst reading since March 2009; in Taiwan, headline PMI fell to 47.1 in May from April's 50.7; PMIs for Vietnam and Indonesia "suggest that manufacturing conditions weakened markedly in Vietnam and slightly in Indonesia," he said.
In China, the two PMI data the final flash HSBC PMI and the official PMI showed diverging trends, with analysts blaming seasonal factors and the different companies that are surveyed for the two indices.
In emerging Europe, PMIs surprised by showing some encouraging signs. Czech PMI came in at 50.1, the highest level in over a year and Polish PMI remained in contraction territory but rose to 48 from 46.9.
But, as Capital Economics emerging markets economist William Jackson pointed out, manufacturing in Turkey, while remaining the strongest in the region, showed that new export orders fell to a six-month low and suggests that the economy "was slowing even before the outbreak of protests over the past few days."
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