Debt Flows’ Cascading Crimp

Emerging market local and hard currency debt flows over $50 billion continued to swamp negative equity ones into August, and looked for year-end direction as retail investors unloaded in the wake of the Chinese devaluation-manipulation saga and Washington’s 10% across-the-board tariff surcharge. It will dent growth around half a point and ricocheted through Asian trade partners and Latin American commodity exporters in particular, with Europe otherwise occupied by flat expansion and inflation expected to spur new ECB chief Lagarde into more asset buying. Only one-tenth of the debt exposure has been domestic with the strong dollar and global central banks led by the US Federal Reserve on a rate-cutting spree. ETF exposure has been modest at $5 billion, and strategic holders like insurers and pension funds remain committed. They have yet to reposition for extended monetary and commercial conflict, and external sovereign and corporate technicals were favorable before the blowup. On the former over $110 billion has been placed on pace for $150 billion in total, with the Gulf a core segment after joining the EMBI benchmark. The latter has tripled that volume on the way to a $400 billion finish, with July unusually busy and Asia still half the field. Tenders and buybacks continue strong with a $50-75 billion estimate by December. However with the US Treasury yield falling on easing and safe haven purchase valuations are arguably stretched with both gauges’ spreads around 300 basis points. The EMBI’s gap shrank with Venezuela’s removal after extended notice, and with announcement of a full bilateral embargo American holders are stuck with dud paper until an eventual restructuring with a successor government. Russian traders are active but liquidity is absent, and they in turn are worried about additional Washington sanctions outlawing primary sovereign subscription in response to chemical attacks on London-based Kremlin enemies. Marking two decades in power, President Putin also faces stagnant growth and doubled consumer borrowing as protesters take to Moscow’s streets demanding fair municipal elections. Corporate fund managers prefer Russian names with investment-grade ratings, but have turned defensive on commodity credits in particular.

Around China upset also focuses on Hong Kong, in literal lockdown as the police and democracy campaigners fight it out despite Beijing’s withdrawal of a controversial extradition law. Thirty years after the Tiananmen events, the army could be called out to subdue unrest, which has already prompted international travel warnings to the popular shopping and re-export hub. Growth could be erased in the coming months, as stratospheric property values supporting the budget surplus come under pressure with potential exodus. The dollar peg has not come under sustained speculation, but the Yuan is half the intervention basket and serious greenback realignment will force difficult choices. From a financial market standpoint, analysts point out that with the launch of Shanghai’s new tech startup platform to complete the multi-trillion dollar complex Hong Kong’s claim is not as secure as an overriding caution against crackdown. In India as well, local debt holders after Prime Minister Modi’s sweeping reelection were spooked by threatened new taxes and Kashmir’s takeover, with Pakistan vowing to answer with the subcontinent again on a delicate fiscal and nuclear timer.

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