EM weaker amid worsening U.S.-China trade tensions; Argentina recovers after early drop

By Rebecca Melvin

New York, June 19 – Emerging markets debt was weaker Tuesday as global stock markets sold off amid worsening tensions between the United States and China over trade, market sources said.

Argentina’s bonds, which were down 1.5 points to 2 points on the long end at the outset of the session, regained ground later when the Argentine central bank did not sell any reserves in an auction following the close of foreign exchange trading.

“Everyone was waiting for the auction today of the Lebac, which is a major risk,” a New York-based trader said.

But the peso was surprisingly stable following the central bank auction on Monday held to stabilize the peso currency that has fallen about 10% this month. The peso stood at 27¾ bid, 27.80 offered per U.S. dollar on Tuesday afternoon, after opening at 27.65.

The objective right now is to avoid sudden moves, and Tuesday ended up being a good day, contrary to initial expectations, because the currency did not move that much. “It seems like a little better tone, it wasn’t that volatile,” the trader said, noting that Argentina’s century bond at 79½ bid, 80½ offered was even a little bit better on the day despite the strong move lower early on.

Behind the negative risk-off tone early in the day was U.S. President Donald Trump’s latest threat to impose 10% tariffs on an additional $200 billion of Chinese products. The announcement was made on Monday after China’s decision to raise tariffs on $50 billion of U.S. goods over the weekend. The market was waiting China’s response, and there was speculation over what actions China might opt to take since it does not import enough U.S. goods to respond in kind to Trump’s latest move.

“It’s a risk-off day,” said Stifel’s director of emerging markets sovereign desk strategy, Victor Fu, adding that one fear is that China will use yuan devaluation as a weapon in the trade conflict.

The yuan was weaker on Tuesday, and a weakening yuan is not good for commodity exporters or China’s competitors in manufacturing, Fu said.

Argentina was not the only credit lower in early trading. Ecuador’s sovereign bonds were down more than 2 points across the curve on Tuesday, with the Ecuador 2024 notes down about 2 points and the belly of the curve most affected.

Other high-beta credits were also affected, including Turkey, which was down about a point on the long end.

In addition to trade war fears, which was putting a damper on the general environment, there were other factors driving selling.

For Ecuador there seem to be concerns about a financing gap, Fu said. Last week, Ecuador conducted a non-deal roadshow to test investor sentiment, and “the market was unimpressed.”

Asian bonds were also dropping on Tuesday and the Chinese yuan currency was weakening quite a lot, Fu said.

“One concern I have is what becomes of trade with the yuan weakening. It’s not good for commodity exporters and China’s manufacturing competitors,” Fu said.

The devaluation can be used as a weapon to help the country retaliate for Trump tariffs in the face of a lack of actual imports on which to impose counter tariffs. China only imported about $150 billion of U.S. products last year.

That level is below the $200 billion the U.S. has announced as the next round. Devaluation is the latest development in the trade conflict which is “a slowly moving process in a bad direction.” Fu said.

In August 2015, China suddenly depreciated its currency about 3% in a couple of days and the Dow Jones industrial average plummeted 1,000 points in a single day. In early 2016 there was another devaluation and emerging markets suffered, he noted.

If China can make its currency much cheaper it is going to hurt commodity exporters like Brazil and Colombia as well as South Korea, which is a competitor in manufacturing.

Questions surround China debt

Meanwhile China’s current aim to reduce debt, which has been a priority for China’s President Xi Jinping, looks to be under threat. Emerging markets debt players had been watching the initiative and worried that China reducing debt could be another headwind for the emerging markets debt space.

But the current trade conflict is a headwind for China’s plan as an economy that has been starting to show signs of weakness, including weakening investment and household consumption. That could start to show up in weakness in corporate performance and potentially increase corporate defaults – and this would be partly due to credit tightening associated with the Xi initiative to contain debt.

The markets are watching China’s total aggregate finance figures, which last week were down dramatically and which has created an unknown situation, a New York-based emerging markets strategist said.

“If China has to lower demand in China because the credit conditions are tightening, that would have implications for raw materials from Latin America,” the strategist said.

Early Tuesday, after Trump announced the additional tariffs, the People’s Bank of China pumped 200 billion yuan, or $31 billion, of one-year funds into the nation’s banks. Advisers to the central bank said that the move did not mean the bank was loosening its conservative monetary stance but was aimed instead at calming the market and containing any financial stress related to the trade fight. The yuan fell to its lowest level in five months at 6.4743 per dollar. In addition, China’s benchmark Shanghai Composite stock index plunged to its lowest mark in two years.

Most of the U.S. stock market retraced much of the day’s early losses but still ended lower. The Nasdaq stock market ended down only 21.44 points, or 0.3%, at 7,725.45, and the S&P 500 closed off 11.16 points, or 0.4%, at 2,762.59. But the Dow Jones industrial average, which contains several stocks that would be hit hard by a trade war with China, ended down 287.26 points, or 1.2%, at 24,700.21.

© 2015 Prospect News.
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