A massive selloff in China is reverberating through emerging economies, threatening to stifle development and drive everything from equities to currencies and bonds down.
Fresh Covid outbreaks, as well as the government’s strict response, are frightening global investors, who fear that China’s shutdowns would ripple throughout the world, decreasing demand and disrupting supply chains. This is pressuring them to sell not only Chinese yuan, bonds, and stocks, but also the assets of any developing country that relies heavily on trade with the world’s second largest economy.
The outcome is the sharpest drop in emerging markets in two years, similar to the 2015 crisis, when China’s troubles led to a sell-off in their bonds and currencies, as well as a $2 trillion loss in share values. Since then, the country’s significance on the global economy has only grown: it is now the world’s largest importer of commodities, implying that its recession will have a greater impact than ever on raw material exporters and their markets.
In an email, Johnny Chen and Clifford Lau, money managers at William Blair Investment Management in Singapore, wrote: “Given China’s prominence in global supply chains and importance to global development prospects, additional disappointments in the nation’s growth may lead to more contagion risk.” “We believe that countries with strong commercial ties to China are the most susceptible.”
The offshore yuan plunged to its worst monthly loss in at least 12 years as armies of white-suited enforcers converged on Shanghai and Beijing in late April to oversee the mandated testing of millions. The MSCI Emerging Markets Currency Index, which includes the Chinese currency at over 30% of its weight, fell in lockstep. The 30-day correlation between the yuan and the index reached its highest level since September, highlighting the currency’s role in the emerging-market selloff. Panic selling moved to bonds and equities as Shanghai announced its first deaths since the pandemic began.
China’s unexpected currency depreciation raises the possibility of a panic similar to that of 2015.
Because of the magnitude of the losses, Chinese officials intervened to reassure markets that they will assist the economy’s recovery and increase infrastructure spending. They also expressed an interest in resolving technology-related regulatory challenges. Even though authorities did not remove the severe Covid Zero policy that had prompted the fear in the first place, these assurances calmed investors’ nerves. While the yuan did recover on the last trading day of April, most analysts expect the currency to resume its downward trend.
On Monday, the offshore yuan fell 0.6 percent to 6.6827 per dollar. For a holiday, China’s local markets are closed.
Beijing’s 5.5 percent growth target for 2022 is now in doubt, sparking currency depreciation in the next three months, according to analysts from Standard Chartered Plc to HSBC Holdings Plc. This, in turn, might slow growth in nations like South Africa and Brazil, which are already dealing with rising US yields, inflation, and the Ukraine conflict.
“If China’s economy slows significantly, developing market currencies, including the yuan, could see increased and prolonged volatility,” said Brendan McKenna, a currency analyst at Wells Fargo Securities in New York.
In just two weeks, the rand lost four months’ worth of gains, while the Brazilian real, Colombian peso, and Chilean peso had some of the steepest losses among peers. Carry-trade losses soared to their highest level since November.
Money managers swiftly revised their currency forecasts for emerging markets downward. HSBC lowered its Asian currency forecasts, citing China’s economic woes. South Korea’s won and Taiwan’s dollar, according to TD Securities and Neuberger Berman, will be under more pressure.
Prashant Singh, senior portfolio manager for emerging-markets debt at Neuberger Berman in Singapore, says, “We continue to have a cautious posture on Asian currencies, and expect additional volatility until some of these growth concerns abate.”
Routing with Multiple Assets
Currency losses are fueling a selloff in local bonds, which have had their worst first four months on record, with April’s performance being the worst since the pandemic’s height in March 2020. China was once again the largest drag, accounting for 41% of the Bloomberg asset class index. The country’s bonds fell the most in a single month since the financial crisis of 2008, causing double-digit losses in countries as diverse as South Africa, Poland, and Chile.
Equities were not exempt from the wrath of the market. A sell-off in Hong Kong-listed Chinese technology stocks echoed half a world away in Johannesburg. Naspers Ltd., which owns 28.8% of Tencent Holdings, saw its stock plummet to a five-year low. Emerging-market stocks lost $2.7 trillion in market value during a three-week downturn spurred in part by concern over Covid cases in China (and in part by rising US yields).
The lockdown of Shanghai heightened concerns about potential disruptions to global supply networks, causing China’s economy to decline severely in April. According to data released by the National Bureau of Statistics on Saturday, factory activity plummeted to its lowest level in more than two years, with the official manufacturing PMI dipping to 47.4 from 49.5 in March.
“China’s downturn will exacerbate the difficult situation for emerging economies, which are already dealing with high energy prices and tighter monetary policy from major central banks,” said Mansoor Mohi-uddin, chief economist at Bank of Singapore Ltd.
Xi’s pledge to boost growth while tightening controls was met with scepticism.
The following are the key developing market developments to keep an eye on this week:
The latest inflation figures for April will be released by South Korea, Thailand, and Taiwan, with price growth in March reaching at least a near-decade high in all three regions.
The PMI survey conducted by Russia will be one of the first indicators of activity in April, the second full month of President Vladimir Putin’s conflict against Ukraine.
Turkey’s inflation is expected to hit 65 percent in April, the highest level since 2002, but the politically restricted central bank is unlikely to respond.
The monetary policy meeting in Brazil is the focus of the next week, with the yield curve indicating that investors anticipate the central bank will follow through on its promise to hike the policy rate by 100 basis points.
In Chile, the central bank is expected to maintain a more gradual tightening cycle and raise the benchmark interest rate to 8%.