China contagion threatens to derail world’s emerging markets

A widespread sell-off in China is rippling through emerging markets, threatening to wipe out growth and drag everything from stocks to currencies and bonds lower.

Fresh Covid outbreaks – and the government’s tough policy to contain them – are worrying global investors who fear lockdowns in China will resonate around the world, cutting demand and disrupting supply chains. That drives them to sell not only China’s currency, bonds and stocks, but also the assets of all developing countries that are heavily dependent on trade with the world’s second largest economy.

The result is the sharpest slump in emerging markets in two years, not unlike the 2015 meltdown when China’s troubles caused its bonds and currencies to collapse and also wiped out $2 trillion in equity values. Since then, the country’s influence on the global economy has grown steadily: it is now the largest buyer of commodities, meaning its collapse could hit 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 country’s growth could lead to greater contagion risk,” wrote Johnny Chen and Clifford Lau, wealth managers at Singapore-based William Blair Investment Management, in an e-mail. Mail. “We see countries with strong trade ties with China as the most vulnerable.”

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

The magnitude of the losses prompted the Chinese authorities to step in and reassure markets that they will support the economic recovery and increase infrastructure spending. They also signaled a willingness to resolve regulatory issues in the technology sector. Those pledges calmed investors’ nerves, even though authorities had not abandoned the strict Covid-Zero policies that sparked the panic in the first place. While the last trading day of April saw the yuan rally, most analysts expect the currency to continue its slide.

The offshore yuan fell 0.5% to 6.6726 per dollar as of 6:43 a.m. New York, continuing a monthly decline that was the largest in more than a decade. China’s local markets are closed for a public holiday.

Beijing’s 5.5% growth target for 2022 is now being called into question, 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, especially if they are also being shaken by higher US yields, spiraling inflation and the war in Ukraine.

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

commodity pain
The rand gave back four months of gains in just two weeks, while the Brazilian real, Colombian peso and Chilean peso posted some of the sharpest declines among their peers. Carry trade losses skyrocketed, beating their worst reading since November.

Money managers were quick to downgrade their currency outlook for emerging markets. HSBC lowered its forecast for nine Asian currencies, citing China’s economic woes. TD Securities and Neuberger Berman said South Korea’s won and Taiwan’s dollar would come under more pressure.

About Christine Geisler

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