Weaker euro-area may affect Emerging Europe

Subject The fallout in Central-eastern Europe (CEE) from Brexit. Significance While CEE government bond markets are being supported by investor expectations of further monetary stimulus in response to the uncertainty stemming from the UK decision to leave the EU ('Brexit'), the zloty is suffering from both its status as one of the most actively traded emerging market (EM) currencies and concerns about the policies of Poland's new nationalist government. A sharp Brexit-induced slowdown in the euro-area economy would put other CEE currencies and equity markets under strain. Impacts The ECB's full-blown QE is helping keep government and corporate bond yields in vulnerable southern European economies historically low. Uncertainty generated by Brexit reduces the scope for further US interest rate hikes later this year, lifting sentiment towards EM assets. The Brexit vote will increase investors' sensitivity to political risks, auguring badly for Poland. Poland has already suffered a downgrade to its credit rating mainly as a result of the interventionist policies of the PiS government.

Significance Chancellor Angela Merkel faces a rising tide of euro-area members in favour of a policy shift away from austerity and possibly towards more favourable debt deals for euro-area black spots. Adding to the pressure for change, her own voters may prefer a slower pace of debt reduction: German government debt has already been falling as a percentage of GDP -- from over 80% in 2010 to under 77% at the end of 2014 -- and debt is starting to fall in absolute terms as well. The government has delivered enough stabilisation (ie, austerity) and growth to tame the 2009-10 debt surge and maintain its AAA credit rating, but is now over-achieving in terms of its own tough targets because the greater-than-expected fall in debt interest costs is pushing the budget into surplus. Some modest spending adjustments look likely to curb this windfall surplus, yet many will argue that more could be done to re-energise the sluggish economy -- and boost the euro-area. Impacts The plummeting euro will provoke another rise in German exports (already near 50% of GDP) and tensions over Germany's bulging trade surplus. While a fiscal stimulus and/or higher wage payments could address these tensions and raise imports, there is no sign of such action. Germany's critics are gathering support to end austerity, to the point of ignoring the risks of deficit financing and reneging on debts. Ultra-low German bond yields, encouraged by the prospective supply fall, are dragging down euro-area yields, delivering wider benefits.


Subject Global equity market trends. Significance The four main US stock market indices began March at record highs, including the benchmark S&P 500 index at 2,400. Driven by expectations of stimulative and pro-business policies under the new US administration, equity markets are flying in the face of signals from the Federal Reserve (Fed) that interest rates will rise three times this year. The probability of a hike at the Fed’s March 14-15 meeting has risen above 80% on growing price pressures and stronger economic data, buoyed by hawkish comments from several Fed governors, including those who were previously dovish. Impacts Despite the post-election US bond market sell-off, around one-third of the stock of euro-area sovereign debt remains negative yielding. The gap between the two-year US Treasury bond yield and its German equivalent has widened to a record, a sign of rising monetary divergence. The euro lost 2% against the dollar in February as political risks escalated in the euro-area, centred around the French election. The emerging market MSCI equity index is 8.6% up this year, after losing 4.5% from November 9 to end-2016, a sign of higher confidence.


Subject Downward pressure on bond yields. Significance Government bond yields rose in late 2016 as a result of higher inflation and expectations of US fiscal stimulus. However, although GDP growth is picking up in the euro-area, the United States and Japan, inflation pressures remain subdued and US fiscal plans have been delayed. Combined with falling political risk in the euro-area, this has pushed yields down and the global stock of negative-yielding sovereign debt is rising again. Moreover, ultra-accommodative monetary policies continue to supress yields, distorting asset prices and contributing to the mispricing of credit risk. Impacts China’s attempts to crack down on financial leverage is seen as a bigger risk by Bank of America Merrill Lynch than a euro-area break-up. Despite the uncertainty of the UK election result, markets have been calm and the S&P 500 equity index hit a new intraday high on June 9. The loss of momentum behind reflation trading has led the dollar index to fall by 5% this year and it will remain under pressure. US technology shares fell sharply on June 9, raising concerns that their surge this year leaves them overvalued and at risk of a correction.


Significance Pressure is mounting on the ECB to justify its withdrawal of monetary stimulus, following a sharp fall in German industrial activity in November that has increased the risk of Europe’s largest economy slipping into recession in the final quarter of 2018. The downturn across the euro-area, which is dragging down inflation rates and government bond yields, is starting to dampen growth in Central Europe. Impacts The euro-area economy’s outlook has dimmed, with Germany’s ten-year government bond yield plumbing its lowest level since April 2017. The open Hungarian and Czech economies are most at risk from a euro-area slowdown, since the weakness is concentrated in the car industry. However, sentiment towards emerging market bond and equity funds has improved despite a global growth scare centred around China’s economy.


Subject Political and policy risks in Emerging Europe. Significance Although the currencies and government bond yields of Central European economies remain stable, the region's equity markets are coming under increasing strain, partly because of political risk. However, strong demand for Turkish local debt suggests there is still appetite for higher-yielding emerging market (EM) bonds. Impacts The recovery in oil prices is helping underpin favourable sentiment towards EMs despite persistent vulnerabilities and risks. Waning confidence in the efficacy of monetary policy will increase investors' sensitivity to political risks in EMs. This is particularly the case if these risks undermine the credibility of countries' policy regimes. Many Latin American economies have been forced to hike interest rates to counter a surge in inflation. By contrast, historically low inflation lets Central-Eastern Europe's central banks keep monetary policy ultra-loose.


2020 ◽  
Vol 21 (4) ◽  
pp. 417-474 ◽  
Author(s):  
Ralf Fendel ◽  
Frederik Neugebauer

AbstractThis paper employs event study methods to evaluate the effects of ECB’s non-standard monetary policy program announcements on 10-year government bond yields of 11 euro area member states. Measurable effects of announcements arise with a one-day delay meaning that government bond markets take some time to react to ECB announcements. The country-specific extent of yield reduction seems inversely related to the solvency rating of the corresponding countries. The spread between core and periphery countries reduces because of a stronger decrease in the latter. This result is confirmed by letting the announcement variable interact with the current spread level.


2014 ◽  
Vol 6 (3) ◽  
pp. 212-225 ◽  
Author(s):  
Norbert Gaillard

Purpose – This paper aims to shed new light on the inability of credit rating agencies (CRAs) to forecast the recent defaults and so-called quasi-defaults of rich countries. It also describes how Moody’s sovereign rating methodology has been modified – and could be further improved – to solve this problem. Design/methodology/approach – After converting bond yields into yield-implied ratings, accuracy ratios are computed to compare the respective performances of CRAs and market participants. Then Iceland’s and Greece’s ratings at the beginning of the Great Recession are estimated while accounting for the parameters included in the new methodology implemented by Moody’s in 2013. Findings – Market participants outperformed Moody’s and Standard & Poor’s in terms of anticipating the sovereign debt crisis that hit several European countries starting in 2008. However, the new methodology implemented by Moody’s should lead to more conservative and accurate sovereign ratings. Originality/value – The chronic inability of CRAs to anticipate public debt crises in rich countries is dangerous because the countries affected – which are generally rated in the investment-grade category – are substantially downgraded, amplifying the sovereign debt crisis. This study is the first to demonstrate that Moody’s has learned from its recent failures. In addition, it recommends ways to detect serious threats to the creditworthiness of high-income countries.


Subject Prospects for emerging economies to end-2016. Significance Despite political risks causing bouts of volatility in countries such as Brazil and Turkey, emerging market (EM) growth prospects have improved moderately and asset prices have rebounded after the turbulence of early 2016. More stability in exchange rates has helped, with the US Federal Reserve (Fed) holding off raising rates. The rebound in commodity prices has been supportive, too, together with receding concerns about China's slowdown. Some countries have also eased fiscal policy to reduce social tensions risks.


Significance This month, 3 trillion dollars had been wiped off the value of all listed companies since a seven-year high on June 12, undermining confidence in the government's ability to steer the market. These developments along with the lingering risk of a Greek exit ('Grexit') from the euro-area, despite the provisional agreement reached on July 12, are taking a toll on emerging market (EM) asssets more broadly. Impacts The emergency measures aimed at stemming the sell-off in Chinese equities will help stabilise the stock market. Foreign investors' exposure to China's retail-based equity market is likely to remain limited. The renewed Brent crude price fall, down 14.2% since early May, will pressure oil exporters' currencies while benefiting oil importers.


Subject The sharp fall in global sovereign bond markets since late September is putting emerging market assets under pressure. Significance Global sovereign bond markets suffered their sharpest monthly loss in October since the 'taper tantrum' of May 2013. Emerging market (EM) assets had rallied strongly as investors sought higher yields amid ultra-low or negative yields in advanced economies. However, fears of higher inflation in the United States and the United Kingdom, coupled with growing concerns about the efficacy of ultra-loose monetary policies, have pushed up the yields on benchmark UK and US ten-year bonds, reducing the relative attractiveness of EM yields. Impacts Investors will continue to favour EMs with strong fundamentals and lower political risks. EMs are likely to lead the eventual recovery of global trade, keeping their assets in the limelight for investor attention. The EM rally not only reflects a search for yield in a low-rate universe but also improved EM economic fundamentals. The surge in EM private debt remains a concern, particularly corporate debt which has risen rapidly since 2008.


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