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China Supplants Fed as Biggest Risk for Emerging Markets

China Emerging Markets
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EDITOR NOTE: Emerging markets around the world have been reacting negatively to talk of the Fed tapering the massive pandemic stimulus measures but are in for an even bigger shock coming out of China. The Evergrande debt crisis has hurt the world’s second-biggest economy, and the next news coming out is expected to be bad as well. Yahoo! Finance reports that official and private gauges of Chinese manufacturing are coming this week, and they’ll likely show massively slowing growth in China. This news could pull down assets in the commodities sector like oil and copper and many emerging markets with it. As much trouble as the U.S. economy is in China looks like it’s now in more danger. 

Emerging-market investors are about to find out whether there’s more to worry about in China than just the Evergrande debt crisis.

Official and private gauges of Chinese manufacturing are due out Thursday, with expectations they’ll add to evidence of sputtering growth. Concerns that the world’s second-biggest economy is slowing have hobbled the currencies and stocks of developing nations in recent weeks, erasing gains sparked by the U.S. Federal Reserve’s assurance of a calibrated tapering of its stimulus measures.

China has now emerged as their biggest risk. While Evergrande has sparked fears of a property-market slowdown, investors worry even more about the stalling of the broader economy due to virus curbs and spending cuts by consumers. Some are looking to diversify into markets less reliant on China’s growth, such as India and Egypt.

“The risks of contagion and further slowing in the property sector are genuine,” Goldman Sachs Group strategists, led by London-based Kamakshya Trivedi, wrote in a note last week. “However, for the rest of emerging markets, what matters more is the negative impact on Chinese growth, and by extension commodity prices, and whether policy makers step in to offset those downside risks.”

Stock, Currency Volatility in Sync as Fed, China Risk Take Hold

This week’s Chinese data will also act as a barometer of demand for commodities such as oil and copper, which exporting nations from Angola to Peru depend on to drive their own growth.

The Caixin gauge of China’s factory activity showed a contraction for August, the first reading below 50 since April 2020. The official measure of manufacturing has declined for five successive months. Retail sales, industrial production and investment have all slowed, confirming the deceleration.

Economists are already warning of lower economic growth as electricity shortages worsen in China, forcing businesses to cut back on production. The stringent measures to pare electricity use will probably cause the purchasing managers index to drop below 50, Nomura said in a report Monday.

Meanwhile, Evergrande is developing into a cliffhanger, with another payment due this week as part of $669 million of bond interest that must be paid through the end of this year. Regardless of the immediate outcome, working off the leverage incurred over a slowing property market may be messy and take some time, according to Goldman strategists.

China’s economy will now grow at a slower-than-expected pace in the years through 2023, according to Bank of America Corp. It lowered its forecast for 2022 to 5.3% from a previous estimate of 6.2%.

“Beyond the immediate concerns associated with Evergrande, China’s recent struggles with the delta variant, tech-centered crackdowns, and now the property sector will likely shave a bit off of global growth at the margin,” said John Lau, head of Asian equities at SEI.

Contained Contagion

Some investors are trying look past the Evergrande crisis on growing optimism the Chinese government will step in at some point and prevent wider contagion.

“The extent of the Evergrande fallout is taking center-stage, but Chinese state support for its operations as opposed to its listed securities should allay some of the worst-case-scenario fears,” said Hasnain Malik, the Dubai-based head of research at Tellimer Research.

Worries over China come after a respite from the Fed, which said it was getting close to reducing stimulus but kept the door open to extend it as needed. Chair Jerome Powell also stressed that the process wouldn’t offer a direct signal on the timing of lifting rates.

“The message from the Fed was one of a dovish policy and ongoing market support if needed, which is positive for risk assets,” said Todd Schubert, head of fixed-income research at Bank of Singapore Ltd.

Diversification Wagers

Those who believe China’s troubles won’t spell doom for emerging markets was a whole are betting that it leaves room for some smaller nations to start outperforming.

Emerging economies with high real interest rates are better prepared for a world where the U.S. tightens policy and China slows down, according to Tellimer’s Malik. Markets including Egypt, Ghana, Indonesia, Vietnam and the United Arab Emirates look promising, he said.

Bank of Singapore, while still buying BB and BBB names in China’s property sector, is looking for bargains in Indonesia and India in case a contagion-induced selloff materializes.

“Indonesia and India are the largest Asian credits that remain as options for diversification away from China,” Schubert said.

These are the events and data to look out for this week:

  • China’s official and Caixin PMIs for September are likely to “perk up from last month’s disappointing readings,” Bloomberg Economics said in a report

    • Still, the nation’s economic recovery will remain pressured by risks from small-scale outbreaks of Covid-19, tighter regulations on sectors from tech to property, and the uncertainty surrounding the Evergrande debt crisis

  • Colombia is set to join its Latin American peers with its first rate hike in five years on Thursday after inflation accelerated beyond its target in August

    • The Colombian peso has been the top performer in Latin America after its Mexican counterpart in the past month

  • Banco de Mexico is likely to hike rates for a third straight meeting on Thursday after mid-month inflation jumped

  • In Brazil, Tuesday’s minutes of last week’s central bank meeting will come under scrutiny after policy makers pledged another full percentage-point hike next month to contain price shocks. The central bank has launched the world’s most aggressive tightening cycle this year, raising borrowing costs by 425 basis points since March, with only limited impact on prices

    • The country will release its quarterly inflation report on Thursday

  • Bank of Thailand’s rate decision on Wednesday will be closely watched, after the previous meeting in August saw a split vote, with dissenters calling for a cut as risks to growth persist

    • Most economists surveyed by Bloomberg expect the central bank to keep policy on hold

(Adds impact of power crunch on economy in seventh paragraph, comment by SEI manager in 10th)

Originally Posted on Yahoo Finance

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