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International Economics Weekly - 6/27/22

Welcome to the first edition of International Economics, a weekly roundup and review of the key stories moving global markets. We would love to hear any feedback, news ideas, or thoughts for improvement as we start out.


Long-Feared Rate Rises Begin to Crush Emerging Markets.


Emerging market debt loads, long elevated, appear increasingly unstable as a strong dollar, aggressive Fed tightening, and still-rising energy and food prices degrade the balance of payments across EMs. According to Bloomberg, the spread between JPMorgan's EMBI index of dollar-denominated EM bonds and US Treasuries has surged over 100 bps. This has led to international investors increasingly shunning EM debt, with over $38bn in outflows in 2022, according to EPFR data.


The World Bank reckons almost 60% of the lowest-income countries were in debt distress before the Ukraine war this year. The rhetoric around EMs is similar to the false alarms during covid when mass defaults were avoided due to ample international liquidity. However, EMs can no longer count on this cheap money to paper over problems.


Sri Lanka offers a prime example of how these external shocks are driving crises. Its stock market has plummeted 64% in dollar terms this year. Public anger over rising food and energy prices triggered the collapse of the government last month and pushed the south Asian nation to default on its debt.


Facing over $5.5tn of bond and loan redemptions in 2022, the additional shocks of more expensive commodity imports, weakening local currencies, and a collapse of liquidity all make additional defaults likely. The most vulnerable countries, like Laos, Pakistan, Egypt, Tunisia, Ghana, Kenya, South Africa, and Ethiopia, have substantially elevated debt levels despite limited foreign exchange reserves. However, changes in creditor composition make fast and orderly debt restructurings unlikely. In recent years aggressive private creditors and opaque Chinese policy banks have replaced western 'Paris Club' bilateral lenders as the largest buyers of EM debt.


ECB promises to combat divergent borrowing costs.


A sudden increase in the spread between Eurozone members' borrowing costs is ringing alarm bells about the possibility of a second Euro crisis as creditors reappraised credit risks in a eurozone about to exit an era of ultra-loose monetary policy. The spreads between peripheral and German bonds have soared to levels not seen since early in the pandemic. Rather than Greece risking the stability of the currency bloc, Italy is proving the most vulnerable, with Italian 10-year paper hitting 240 basis points higher than the yield on German bunds. Such fragmentation comes as the ECB ratchets up its monetary policy and tapers its balance sheet.



Italy-Germany 10-Year Bond Spread. Via YCharts/Eurostat.


Italy's economic downturn — and expectations of rate increases from the European Central Bank beginning in July — are reviving concerns about the health of Italy’s longer-term finances. With the second-highest debt-to-GDP ratio after Greece and the highest government deficit of any major Eurozone economy, Italy’s position is precarious. Markets have grown gloomier on its prospects, given low productivity growth and fiscal consolidation. A target budget deficit of 5.6 percent is forecast for this year, down from the 7.2 percent recorded for last year. But economists warned that a sharp slowdown in growth would raise doubts about the deficit.


Facing similar spreads in the past, the ECB has tactically bought government bonds to help reduce spreads. True to form, the governing council called a rare emergency meeting where they announced the development of an "anti-fragmentation tool." While there was no detail on how the ECB’s new instrument would work, some analysts think it could be an updated version of the securities markets program that allowed the bank to tackle market fragmentation by buying €220bn of sovereign bonds between 2010 and 2012. Whatever the tool, the ECB's reaction has been widely heralded as a step forward for a common European economy and the institution's evolution into increased receptiveness to peripheral economies' needs. However, the likelihood of resumed, albeit more tactical, bond buying will require sophisticated sterilization to ensure it doesn't undermine the ECB's tightening efforts. Christine Lagarde's final admission that the bank's mandate does include spread compression reveals the likelihood that easy money has lead to fiscal dominance as divergent economies are scarcely able to stand without a monetary crutch.


VC flows to Africa holdup despite increased investor caution.


Rising interest rates and decreased liquidity have brought investors back down the risk curve, yet African startups have continued to attract venture capital, reports Bloomberg’s Antony Sguazzin and Rene Vollgraaff. Dampening risk sentiment has hit early-stage startups and emerging markets especially hard as investors flood into safe-haven assets. Despite a broad pull-back in venture funding, VC interest in emerging markets looks likely to continue, according to a recent report by the African Private Equity and Venture Capital Association (AVCA).


Despite a projected decrease from the $5.2bn in 2021, African startups have seen $2.7 billion since January, more than double the $1.2 billion in the first five months of last year, according to data collected by Futuregrowth Asset Management. These figures suggest that investors are still bullish about the booming startup ecosystem in countries like South Africa, Nigeria, Egypt, and Kenya. While continued activity from Tier 1 VCs like Sequoia and Tiger suggests a long-term commitment to the continent, investor behavior is changing. In an effort to de-risk in what looks likely to be a recessionary environment, VCs are increasingly focusing on Series C and beyond in less speculative sectors like payments, AgTech, and Health.


BRICS countries consider creating a reserve currency.


At the 14th BRICS Summit, Beijing took the opportunity to promote its governance and development models while railing against unilateral sanctions. The venue paid lip service to the standard goals of promoting "true" multilateralism, boosting security cooperation, and trying to forge stronger trade ties. BRICS format has lost much of its former sway, and its difficulties were on full display as India and Brazil both struggled to maintain neutral stances amid strong winds from the east.


However, not all was lost as unaffiliated countries like Argentina and Iran expressed interest in joining the bloc of large and independently-minded EMs. Russia led discussions on a BRICS reserve currency on the heels of US sanctions which have accelerated sanctions resilience efforts in countries wary of Washington’s wrath. While there are cyclical claims of the dollar's death, this would mark a serious challenge to the IMF's special drawing rights (SDR) and the US’s power within the institution. A basket of BRICS currencies would effectively formalize a sphere of influence and unit of currency within that sphere. This would serve Russia especially well in an effort to address the mounting pressure on its capital account. Whether the initiative comes to fruition, a BRICS format reinvigorated by real currency alignment would further contribute to the fragmentation of the current economic order around geopolitical blocs.


Protectionism Rises in Commodity Producers, Promising Higher Costs in the Long Run.

President Biden doubled down on interventionist energy policy this week, calling for a three-month suspension of the federal gas and diesel taxes in addition to his calls for export curbs on US energy companies. While these proposals have been panned by both parties in the legislature as both insufficient and inflationary, the move marks a return to 1970s economic policy driven more by political expediency than economic reality.

With CRISIL estimating that every $10 increase per barrel of oil raises the headline consumer price index by about 40 basis points, countries around the world have returned to subsidies, trade barriers, and excise tax reductions that have a neutral impact at best and do real damage at worst. Similar policies are active in Asia, where India has paused its excise tax while South Korea and Japan are experimenting with direct subsidies. Such policies create a tricky balancing by increasing fiscal deficits, reducing revenues, contributing to inflation, or all of the three in the case of countries like Thailand.


A worker transports palm fruits at a palm oil plantation in North Sumatra, Indonesia. Via CNN


The calls for energy export bans, however, mark a more sinister return to the beggar thy- neighbor trade policies that have historically exacerbated downturns. Restrictions on the export of key staples like grain from Ukraine, palm oil from Indonesia, and beef from Argentina have become increasingly popular as food shortages and increasing global hunger has serious political consequences. While such short-termism may be politically expedient, interventionist policies only create further supply imbalances and accelerate global inflation.


Layoffs hit finance sector as the US housing market cools.


Rising interest rates are hitting mortgage demand, leading big banks to follow the layoffs seen in tech and financial startups startups. JP Morgan announced over a thousand effected employees in mortgage servicing and origination while Wells Fargo decided to pull out of its mortgage business altogether. Mortgage rates have increased rapidly, with the average rate for a 30-year loan reaching 5.78% last week, the highest since 2008. The prospect of lower demand has triggered price cuts for both sellers and builders.


A Bloomberg analysis showed that OECD countries are currently seeing combined price-to-rent and home price-to-income ratios higher than they were ahead of the 2008 financial crisis. However, warnings of a repeat of 2008 are unlikely amid continued supply shortages, tighter lending standards and higher household savings. Economists also point to secondary support for demand as prices cool and buyers priced out of a frothy market are able to purchase.


In Other News


Why China is not rising as a financial superpower. (FT)


China Asks Foreign Business Leaders How to Revive Hong Kong in Rare Move. (Bloomberg)


International investors cash in on China’s pension market. (FT)


India, EU resume free trade talks after near-decade freeze. (Nikkei)


After the war ends, can Ethiopia’s economic ‘miracle’ get back on track? (FT)


South-east Asia bucks global stagflation trend as tourism and exports climb. (FT)


Sunak urged to save £57bn by withholding BoE interest on reserves. (FT)


Yen drops to fresh 24-year low vs U.S. dollar. (Reuters)


Rising prices cause rising tension between Biden and Hill Dems. (Politico)


Interest Rates Are Well Below What Academic Formulas Suggest, Fed Report Says. (WSJ)


With Markets in Disarray, International Investors Are Stockpiling US Dollars. (WSJ)


Global money ditches Big Tech for a new group of stocks. (Nikkei)


Four big U.S. banks raise dividends after stress tests. (Reuters)


How selling to yourself became private equity’s go-to deal. (FT)


Frozen tax allowances and inflation chill investors. (FT)


US business borrowing for equipment rises 16% in May - ELFA. (Reuters)


Companies Face Rising Supply-Chain Costs Amid Inventory Challenges. (WSJ)


Why pay rises for your company’s ‘flight risks’ can backfire. (FT)


Companies Brace for Impact of New Forced Labor Law. (NYT)


Small Businesses Fall Behind on Hiring as Inflation Takes a Toll. (WSJ)


IEA chief warns Europe to prepare for total shutdown of Russian gas exports. (FT)


Global steelmakers face $518bn in stranded asset risk. (FT)


Nuclear Power Is Poised for a Comeback. The Problem Is Building the Reactors. (WSJ)


`We grew too quickly': Crypto faces reckoning as market rocked. (Politico)

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