The Turkish Lira Continues To Slide, Are Bonds Next?

The Turkish lira is languishing at near record lows as December dawns.

The currency, which touched its lowest ever levels against the US dollar on November 23, found itself close to that level as November ended and December began — and its slide may not be over yet.

Further weakness in the lira will impact local currency-denominated bonds unless steps are taken to counter its decline.

How can the sliding lira impact Turkish bonds?

Between local currency-denominated equities and bonds, currency movement generally has a bigger impact on the latter since the absolute returns are usually smaller.

A weakening local unit will lower returns from a bond denominated in that currency when converted to the comparable foreign unit. Hence, since the Turkish lira has been declining against the greenback, returns from Turkish bonds denominated in the lira will fall when converted into dollars. Conversely, Turkish bonds denominated in dollars would see their returns rise.

This can be expected to be the case going forward, given market expectations of a further weakening in the lira.

But there is a caveat.

Central bank action

Turkey has been wrestling with elevated levels on inflation; it has been in double digits for most of 2017 so far. As shown by the graph below, after falling into single digits in July, prices began to rise again and for October, they stood at their highest level in nine years.

If the Central Bank of Turkey were to raise its key rates at this juncture, it would not only help in controlling price rise, it will also support the sliding lira.

But will the central bank take this action, and why has it not done so already?

The answer lies with the now even more empowered presidency.

In late November, President Recep Tayyip Erdoğan had said that the “artificial inflation” in exchange rates would revert to normal soon.

During the event, he also reiterated his belief that higher interest rates actually caused inflation rather than restraining it.

Apart from his belief, another reason why the President wants interest rates to remain low is to enable cheap credit via which he intends to fuel economic growth as well as maintain his popularity with people.

Hands tied

This stance by an exceptionally powerful political establishment has prevented the central bank from undertaking an aggressive rate action. Its one-week repo, overnight lending and late liquidity window rates continue to remain at 8%, 9.25% and 12.25% respectively. The last major change in the one week repo rate was effected in November 2016.

The central bank has taken some other steps and indirect measures to curtail inflation and support the lira though.

From November 6, it decreased the amount of foreign currency that lenders are required to park with the regulator. This unshackled $1.4 billion of foreign exchange for banks. It also allowed exporters to repay up to $5 billion in forex loans not due until February in lira at promising rates.

Recently, the central bank disallowed lenders from using its aforementioned 9.25% interbank overnight rate facility, thus forcing them towards the 12.25% late liquidity window. This was intended to lift the bowering costs for banks, thus tightening the monetary stance a bit, albeit indirectly.

But given the multi-year high levels of inflation, these measures may not suffice to contain price rise and may also prove to be insufficient to provide a floor to the lira. This also means continued lower returns from bonds.

Though an aggressive stance by the central bank is warranted, its possibility remains low. However, some rate action in its upcoming meeting would be required to boost sentiment towards the Turkish lira failing, in which case a further decline in both the currency and returns on local bonds can be expected.

Shot In The Arm: Can Copper Prices and Debt Management Fuel A Rebound In Zambia?

Economic growth in Zambia has taken a hit in the past two years as can be seen from the graph below. Domestic output in these years rose at less than half the pace seen in 2012 and 2014.

Much of the slowdown has to do with copper. The non-ferrous metal forms over 70% of the country’s exports, as shown in the graph below.

Zambia is Africa’s second-largest copper producer. According to London Metal Exchange data, copper prices fell by 13.7% in 2014 and by 26% in 2015, thus impacting output in the following years. However, things may be looking up.

The graph above displays the recent rise in copper prices, which is expected to provide a shot in the arm to the country’s economic growth. Finance minister Felix Mutati expects the economy to grow by 5% in 2018 from an expected 4.3% this year.

As of October 17, copper prices have risen by 26.7% in 2017 while Zambia’s copper exports have shot up by 38% through August, thus helping the economy expectedly grow over the 4% level for the first time in three years.

Challenges and concerns

After a tumultuous couple of years, Zambia finally finds itself in a position from which it can look to a brighter future. It continues to face challenges, but has seen some economic indicators turn favorable.

For instance, while inflation at 6.6% for September seems high, it is down markedly from double digits just a year ago and has dropped from over 20% in early 2016. Resurgent copper prices, as seen above, have supported the otherwise flagging economy.

However, rising debt remains a serious concern for the country, and can have implications for fixed income investors – an scenario which the government intends to address.

In a recent review, the International Monetary Fund (IMF) had a positive view on the near-term outlook for the country’s economy due to rising copper prices and good rainfall which has helped power production. However, it also cited high debt, fiscal consolidation, and revenue mobilization as issues.

According to the IMF, the fiscal deficit on a cash basis had stood at 9.3% of gross domestic product (GDP) in 2015, two times its budgeted level.

The institution viewed the pace of growth of public debt as “unsustainable”, pointing specifically to the risks it poses to the private sector.

It noted that outstanding public and guaranteed debt rocketed from 36% of GDP in 2014 to 60% in 2016, primarily due to external borrowing and weakness in the Zambian kwacha.

Action plan

Apart from rising copper prices, prudent policies are required to enhance the attractiveness quotient of Zambia among African nations.

The country has launched the Economic Stabilization and Growth Program and the Seventh National Development Plan in that direction. Further, finance minister Mutati is of the opinion that the 2018 National Budget will address the IMF’s concerns. The budget aims to reduce the fiscal deficit to 6.1%.

Zambia also intends to increase revenue collection by the Zambia Revenue Authority (ZRA). Mutati said that the ZRA would aim to increase tax compliance from56% currently to 76% going forward.

Impact on bonds

Zambia has been undertaking reform measures in order to procure a $1.3 billion loan from the IMF which has so far eluded them due to high public debt.

Reining in public debt is important also in order to keep its borrowing costs low. The graph above shows that the average auction yield on the 10-year bond has come down, easing some pressure on government finances.

Zambia’s external debt rose to $7.6 billion by the end of August 2017 from $2 billion at the end of 2011. This includes three Eurobond issuances from 2012 until 2015 amounting to a cumulative $3 billion. The earliest of these issuances falls due in September 2022 and concerns over debt would raise questions on the repayment ability of the government, thus hurting investors in these bonds. At this juncture, increasing copper prices could play a strong role in improving the health of the economy.

Negotiations Over NAFTA Are Weighing On Mexico’s Currency And Bonds

Mexico has been an anomaly in Latin America when it comes to monetary policy this year. All its major peers – Brazil, Peru, Chile, and Colombia – have slashed their key rates in YTD 2017. On the other hand, Banco de Mexico has been hiking its Official Overnight Rate as shown by the graph below.

At 7%, the rate is at its highest since early 2009. The central bank had to continue increasing the overnight rate in order to combat inflation which has itself reached a level not seen since the end of 2008.

The Mexican peso was one of the factors putting pressure on inflation.

As shown in the graph above, the currency has had quite an eventful one year. Its weakness against the dollar post the US Presidential election in November last year, which bottomed out on the eve of the inauguration of President Trump, put considerable pressure on consumer prices in Mexico.

The peso, which had declined nearly 6% against the greenback by January 19, later reversed course and rose 15.7% by mid-July, thus taking some pressure off inflation.

Hopes of a rate cut and impact on bonds

The Banco de Mexico last raised its overnight rate in June 2017 and had indicated the action may mark the last step in the rate hiking cycle. Its hawkish stance on inflation may be paying off with consumer prices declining for September as shown by the graph below.

But even after the small dip, inflation remains much higher than the central bank’s target range of 3%, plus or minus one percentage point. However, there are other concerns.

Negotiations over North American Free Trade Agreement (NAFTA) have been a big hurdle in the path of a rate cut. Recent developments have hurt Mexican financial assets across the board including its currency and bonds, as shown in the graph below.

The hawkish stance of the US Federal Reserve is another problem. In the past, Banco de Mexico has raised rates in sync with the US central bank in order keep local currency-denominated bonds attractive. Given that its rate tightening cycle may be at an end, further rate hikes by the US could reduce the appeal of Mexican bonds.

Had it not been for these issues Mexico’s central bank would have been in a position to effect a rate cut, given their confidence that inflation would continue to fall closer to their target in 2018.

If outgoing governor Agustín Carstens deems fit, he can push for a rate cut before his tenure at the helm of the central bank finishes in November.

At this juncture, odds seem to favor a status quo on policy rates. However, if a rate cut is effected, though it will dent bond yields in Mexico, it will help to anchor inflation expectations and can provide a leg up to the economy. Renewed confidence in the economy can keep Mexican bonds in play for some time before an easing cycle is firmly in place.

How Will Thailand’s Bonds Be Affected If The Central Bank Decides On Rate Cuts?

The government is not seeing eye-to-eye with the central bank of Thailand when it comes to monetary policy in the country.

The government, particularly the finance ministry, has expressed that it wants monetary policy to complement its fiscal policy efforts to help increase the country’s economic output.

Compared to some of its regional peers, Thailand has not been growing particularly quickly. In Q2 2017, its economic output rose by 3.7% from a year ago, up from 3.3% in the previous quarter. Meanwhile, Indonesia’s economic growth stood at 5.01% and Malaysia grew by 5.8% in the same period.

Providing credence to the government’s appeal is the low level of inflation in Thailand. Consumer prices rose by 0.86% year-over-year in September, below the floor of the 1-4% target range of the Bank of Thailand. This shows the central bank has headroom to reduce its benchmark rate, which has stood at 1.5% since 2015.

The inflation argument has the support of the International Monetary Fund as well. But then there’s the baht.

The Thai baht has been the best performing currency in Asia. Until October 12, the unit was up 7.5% against the US dollar in this year.

The strength of the baht is detrimental to Thailand’s exports, and low exports drag on economic output. Coupled with slow inflation and relatively low growth, a strong domestic currency also presents a case for a rate cut.

However, on its part, the Bank of Thailand has stuck to its position of maintaining its key rate at 1.5% as it holds that a rate cut at this juncture could increase risks to financial stability. Cheaper credit would raise already high levels of indebtedness.

As far as economic expansion is concerned, the central bank holds that growth is above trend. It recently upgraded its view on the rise in economic output to 3.8% for both this year and the next from 3.5% and 3.7% in its July forecast.

Meanwhile, the central bank has been intervening in the forex market to control the rise of the baht as it feels that a rate cut will not have the desired effect of weakening the currency being that investors are confident in the economy. The weaker dollar has swelled the country’s forex reserves to over $200 billion.

Rate cut, inflation and bonds

Inflation is one indicator that continues to remain low even though Thailand’s central bank expects economic growth to pick up. And subdued consumption and weak wages are expected to continue putting downward pressure on price growth.

Bank of Thailand now expects inflation to be 0.6% in 2017 and 1.2% in 2018, down from 0.8% and 1.6% respectively according to its July forecast.

Consumption spending is expected to rise after the mourning period over the passing of HM the late King Bhumibol Adulyadej ends on October 27. This can help resuscitate inflation, apart from supporting economic output.

The chances of a rate cut in Thailand are not exceptionally high. However, if inflation continues to disappoint and the baht remains strong, thus impacting economic output, the central bank may need to move to ease monetary policy.

Though Thailand’s yield curve is upward sloping, yields across most maturities have declined this year.

Low inflation expectations have already led to a 50 basis point decline in yields on Thailand’s 10-year bond this year. From its peak towards the end of 2016, the yield on the bond is down 70 basis points.

In the medium-term, a rate cut can help raise inflation expectations and thus increase yields on longer-term bonds. This can steepen the yield curve, thus opening up opportunities for investment.

Though the Bank of Thailand is not going to base its policy stance on movement in bond yields, it can be a good indicator of what the market feels, especially about inflation. And at this point in time, the market view is not positive on inflation growth.

Tracking The Greenback In Order To Invest In Emerging Markets Equities and Bonds

The US dollar has weakened for most of YTD 2017. This is reflected in the performance of ETFs tracking the greenback.

While the PowerShares DB US Dollar Index Bullish Fund (UUP) is down 8.6% for the year, the PowerShares DB US Dollar Index Bearish Fund (UDN) is up nearly 9%.

In the previous two articles of this series, we’ve established the visible relationship between the greenback and emerging markets equities and bonds. So, if the dollar strengthens, what impact can it have on these instruments?

Emerging markets equities

Since the turn of the century, emerging markets equities have done well when the dollar has weakened. So does that mean that a strengthening dollar spells doom for them?

Not necessarily.

If the strengthening dollar is driven by a surging economy, then a portion of the funds invested in emerging markets will move back to the US. However, given the vast universe of emerging markets, there will be pockets which will continue to provide value. In such a case, reducing exposure to broad-based funds and increasing investments in certain countries could be beneficial.

On the other hand, if the dollar strengthens due to certain developments or announcements such as the US Presidential election last year, it may not impact emerging markets equities. There can be temporary volatility, but no persistent trend of outflows.

Another aspect to note is the decoupling of some emerging markets with the US compared to a decade ago. Though a strong dollar can result in some capital outflows, emerging nations that don’t rely on the US for exports will bear the brunt better than others.

Emerging markets bonds

In the universe of emerging markets bonds, those denominated in local currencies can be at serious risk of falling in value if these currencies weaken against the dollar.

Though the entire universe would suffer because a strong dollar normally triggers outflows from relatively risky emerging markets bonds to the safety of US treasuries, bonds denominated in local currencies can expect to experience a harder landing than those denominated in hard-currency.

A major reason why the asset class suffers is because a weaker dollar typically leads emerging market governments and corporates to raise debt overseas, which, if denominated in dollars, would make it expensive to service, thus increasing their risk. At such a point, the reward does not compensate for the risk, resulting in outflows.

Similar to equities, a strong dollar backed by a strengthening economy would have a bigger negative impact on emerging markets bonds vis-à-vis a short-term upward movement.

Recently, the US Federal Reserve surprised the market by deciding to begin reducing the size of its balance sheet. This fanned the dollar which has since begun rising.

If US economic indicators back this aggressive stance of the central bank, then emerging market bonds will see outflows. A major trigger will be a rise in inflation expectations in the US, which will impact the US Treasuries yield curve.

If this does not happen, then some pockets of emerging markets will still remain attractive due to the higher yields they continue to offer.

The Relationship Between The Dollar And Emerging Markets Bonds: Closer Than Equities?

As we saw in the first article of this series, since the late 1990s, emerging market equities have outperformed when the dollar declines. The relationship between the greenback and emerging markets bonds is even more notable.

The graph below plots the movement between the dollar and the iShares J.P. Morgan USD Emerging Markets Bond ETF (EMB) – the largest ETF investing in emerging markets bonds. It invests in hard-currency bonds.

For the ten year period shown in the graph, the inverse pattern of price movement is strongly visible.

The relationship between the greenback and emerging market bonds denominated in local currency further solidifies this assertion.

The graph above plots the movement between the dollar and the VanEck Vectors J.P. Morgan EM Local Currency Bond ETF (EMLC).

Why is this relationship so close?

The reason why the dollar and emerging markets bonds show this seemingly uncanny relationship is of course because of the greenback itself.

In the case of EMB and other instruments investing in dollar-denominated bonds, the movement in the dollar is directly reflected in the underlying bonds. For ETFs investing in local-currency bonds, the case is similar, but in the opposite direction of their dollar-denominated relatives.

This has been the case in 2017 as the weakness of the dollar against several emerging markets currencies has led local currency-denominated bonds and funds to outperform their hard-currency peers.

Since movements of the greenback have a much higher impact on the returns of bond funds, and is sometimes primarily responsible for their movement, the relationship between the dollar and emerging markets bonds is closer than that of the dollar and emerging markets equities.

A more subtle yet profound point to make here is that when investors are investing in emerging markets bonds, regardless of the denomination, they’re essentially placing a bet on the movement in the dollar and emerging markets currencies.

What does this relationship between the dollar and emerging markets bonds and equities mean for the latter? Let’s assess in the next article.

Romania’s Stock Market Is Up 25%, But Watch These Economic Indicators Closely

Romanian stocks, in the broader spectrum of emerging Europe, have outperformed in YTD 2017. The MSCI Romania Index is up over 25% this year and a shade under 20% in the 12 months ending September 20.

The graph below plots the movement in the Bucharest Stock Exchange’s BET Index.

The BET Index in celebrating two decades in September. It was launched in September 1997 and was originally composed of 10 stocks with a market cap of 443 million Romanian leu ($600 million or 473 million euros at the time).

At present, the Index is made up of 13 stocks and has grown to a market cap of 35 billion leu ($9 billion/7.6 billion euros).

In 20 years, the Index has risen nearly eight times its original value.

Investment fund Fondul Proprietatea SA and Banca Transilvania SA form nearly a fifth of the Index each, and the top five stocks form three-fourths of the Index. Meanwhile, energy majors OMV Petrom SA and ROMGAZ SA are the largest stocks by market cap, in that order.

While Romanian stocks have been gaining, the country’s bonds have been declining.

The graph above, which plots the 10-year government bond yield in the past one year, has a clear uptrend through the period.

It is the sharp movement in both of the above two graphs though, which make for an interesting study.

Political issues and government decision-making

Romania has been politically challenged in the recent past. The present government is the country’s third in the past year, and is a major reason why fiscal policy has not delivered and investment in the country has dwindled.

On a positive note, President Klaus Iohannis has been leading an anti-corruption campaign which aims to clean the system. However, senior politicians have tried to neutralize those efforts by trying to push through laws which serve their interests. Public outcry has ensured that such decrees have not seen light of day.

Markets seem to have reacted positively to the public anger. A major such incident occurred in February when mass protests were witnessed after the government tried to legalize practices which many viewed as corrupt. While stocks surged in the face of this public dissent, bond yields declined as can be seen from the graphs above.

On the flipside, the government has shown a pattern of taking decisions and then rolling them back, thus sending markets into volatile periods.

In June, the government had made public a pension reform and a higher band of income tax, among other measures, but had taken them back after an uproar, especially from the business community. This led to a decline in stocks and a noticeable rise in bond yields.

The macro determinants of financial markets

Fitch Ratings expects economic growth in Romania to slow post-2017 which recently stated that “wages outpace productivity growth” in the country. Though it raised growth expectations for 2017 from 4.8% to 5.1% in its latest forecast, it expects the pace to slow down to 3.4% in 2018.

The state of public finances, as has been discussed in the previous article, remains a cause of concern as well, and can negatively impact financial markets. The country is expected to breach its European Union-set budget deficit limit of 3% even though Prime Minister Mihai Tudose believes otherwise.

The other issue which will continue impact financial markets is political stability and the fight against corruption.

As recently as August, the government proposed measures which were aimed at clamping down on the powers of the President as well as restraining the judicial branch. Romanian stocks had dropped after these proposals while the European Commission had warned that “the irreversibility of the progress achieved by Romania in the fight against corruption in the last 10 years is essential for the Commission”.

It is these aspects, and the changes therein, that will continue to control the state of the Romanian stock and bond markets over the medium-term.

Tajikistan and Ukraine Will Put Appetites of Emerging Market Bond Investors To Test

A strong appetite for emerging markets bonds has emboldened both investors and sovereigns. But that appetite will soon be put to the test by Tajikistan.

The small central Asian country is making its international bond market debut with a 10-year dollar-denominated bond. The country, which was not even rated until as recently as the penultimate week of August 2017 is aiming to raise between $500 million to $1 billion from international investors, according to media reports.

On the other hand, the other country mentioned in the previous article in this series, Ukraine, is no stranger to international bond markets. It was recently reported that the country has appointed bookrunners to issue dollar-denominated debt. Ukraine had last tapped bond markets in 2013 with a $3 billion offering.

The countries are on different spectra as far as their respective sizes are concerned. According to World Bank data, the gross domestic product (GDP) of Tajikistan was $6.9 billion in 2016 after reaching a peak of $9.2 billion in 2014.

Meanwhile, the World Bank estimates Ukraine’s GDP at $93.3 billion in 2016, down from a 10 year peak of $183.31 billion in 2013. Its GDP in 2016 was the second lowest in the past decade with the low-point having been seen in 2015.

Even though its economy is over 13 times larger than that of Tajikistan, Ukraine will be testing appetite as much as the Central Asian nation, albeit in a different manner.

The test

Both countries intend to capitalize on investor hunger for yield, and are each going to test that appetite in their own way.

Tajikistan is the second smallest country among the five central Asian nations. It has no track record of raising money overseas, is plagued by infrastructure issues and non-performing loans, and has a severely underdeveloped financial sector.

The country is overly dependent on remittances from abroad; they account for 45% of its GDP according to data from the International Monetary Fund (IMF). Importantly, its proposed issuance will not be guaranteed by any external organization.

Its issue size and cut-off yield will be indicative of the extent to which investors are willing to stretch for returns as well as their comfort in investing in the absolute fringes of emerging and developing countries. It will also set the bar for other smaller countries from the region, specifically Kyrgyzstan and Turkmenistan, as to how the international investment community is viewing their development agenda.

On the other hand, Ukraine is coming off of a geopolitical situation which had seen Crimea being annexed by Russia in 2014. This had hit its economy hard and led it to default on its 2013 loan. The country has been on an IMF bailout program worth $17.5 billion since 2015.

The debt had to be restructured and investors had to accept a 20% write-off. Legal battles ensued and are still ongoing.

However, two things seem in favor of Ukraine: its bond yields have come down significantly; the 10-year yield is below 7.5%, and the country recently received an upgrade from Moody’s which raised its sovereign rating from Caa3 with a stable outlook to Caa2 with a positive outlook.

Unlike Tajikistan, Ukraine is not on the fringes, but its geopolitical situation and the ongoing lawsuit involving debt default will have a bearing on the yields demanded at its offering. A successful issuance may help it reduce its dependence of the IMF bailout.

The multilateral agency had envisaged the country issuing $1 billion of bonds this year with the size of the offering increasing by $1 billion in the coming two years.

Strong investor response to recent issuances by financially troubled countries Iraq and Greece, apart from Belarus, and a centennial bond issued by Argentina, can provide hope to both Tajikistan and Ukraine for similarly favorable outcomes. The latter has traditionally been an attractive destination in Eastern Europe for fixed income investors.

Comparatively affordable new issuances would indicate that the emerging markets bonds rally may still be on firm ground.

The Largest Sovereign Bond Issuances In Central Asia and Eastern Europe

The emerging markets bond asset class has seen a lot of traction in the past 18 months or so, with particular interest in 2017. Exceptionally high returns have had a lot to do with this as shown by the graph below.

The iShares J.P. Morgan USD Emerging Markets Bond ETF (EMB) is the most widely tracked emerging markets bond fund and has returned 8.6% in YTD 2017. In comparison, the iShares iBoxx Investment Grade Corporate Bond ETF (LQD) has returned 5%, while the SPDR Bloomberg Barclays High Yield Bond ETF (JNK) has returned 5.1%.

Lower tenor ETFs investing in government bonds have fared far worse. The only fund which comes close to the EMB’s performance is the iShares 20+ Year Treasury Bond ETF (TLT) which invests in longer maturity papers; the fund has returned 8% thus far this year.

The interesting thing to note here is that the EMB is not the best performing emerging markets bond fund. Given that several emerging markets currencies have strengthened against the US dollar, funds investing in local currency bonds have outdone their dollar-denominated peers; EMB is a fund investing in dollar-denominated bonds.

The First Trust Emerging Markets Local Currency Bond ETF (FEMB) and the VanEck Vectors J.P. Morgan EM Local Currency Bond ETF (EMLC) have gained 14.1% and 13.5% in the year so far.

Emerging markets bond issuances

Nations classified as developing or emerging, including those on the fringes, have made use of the opportunity provided by the interest in emerging markets bonds to tap international bond markets.

The graph above displays the largest sovereign bond issuances from select countries in central Asia and Eastern Europe in the past five years. The issuance amounts pertain to the cumulative size of each countries offerings and not a single bond. Also, Bulgarian bonds were issued in euros, but have been converted to the dollar value prevailing then.

The reason that we’re analyzing this specific geography is because Tajikistan and Ukraine are on track to tap bond markets soon.

Tajikistan’s neighbor Kazakhstan had tested international waters by issuing its largest bond sale ever a little over two years ago. The planned issuance would mark Tajikistan’s debut in international bond markets and could be used a barometer for three other countries from Central Asia.

In the next article, let’s look at what Tajikistan and Ukraine’s bond issuance could mean for frontier countries on the fringes.

US Treasuries: Why China and India Is Buying, But Japan Is Not

China and Japan account for a combined 36% of all US Treasuries owned by foreign countries, according to the June 2017 data released in the August edition of the Treasury International Capital (TIC) report.

However, while China has mostly been adding Treasuries over the past seven months, Japan has been cautious and has actually reduced its holdings. Meanwhile, Mexico has been selling Treasuries, but India and South Korea have been lapping them up.

The graph below displays a relative analysis of how US Treasuries holdings have changed for these five nations on a monthly basis over the past three years.

Why is China buying, but Japan is not?

China sold US Treasuries aggressively last year in order to defend the yuan which was in decline during a campaign to restrain capital flight. Once the situation stabilized, China resumed its Treasuries purchases.

Even after purchases in recent months, its level of holdings is still lower than the September 2016 level – a month before it lost its top position as the largest investor in US Treasuries to Japan.

The resumption in buying indicates the confidence China has in the stability of its currency and in its economy. Further, the country seems inclined to continue adding to its holdings.

On the other hand, Japan has been cautious about buying Treasuries due to the rising interest rate environment in the US. It does not want to buy at a time when yields are expected to continue to rise.

The case of India and Mexico

The Reserve Bank of India has been on a US bond buying spree, with its holdings for June at an all-time high. Though the Indian central bank, alike Japan, also expects a rise in yields on these securities, the sharp increase in holdings indicate that it expects the rise to be moderate.

India’s high forex reserves have facilitated these bond purchases. If yields on US bonds decline, it would not only benefit the investment the country has made into them, it will also enhance the appeal of Indian bonds as the spread between them and their US counterparts would increase, thus making the former more attractive.

The case of Mexico is different. The country has been selling bonds since the time President Trump announced his candidacy back in 2015. His less than amicable views on the country triggered the sale, and Mexico then continued reducing its holdings after the Republican candidate became a nominee, and then, eventually the President.

Impact

Emerging markets have differing views and assessments on the path of US Treasury yields. A quick or unanticipated climb in yields, which could also result from increased inflation expectations, would be detrimental to those countries ramping up their holdings.

On the other hand, a more gentle increase would be beneficial to such nations, depending on the tenor they have invested in. For instance, a flatter US yield curve would help those nations who have invested in the longer end of the curve as yields on those bonds would decline, thus resulting in a handsome payday for those central banks which had invested at higher yield levels and intend to sell.

Mexico Gives Thumbs Down To US Treasuries, While These Emerging Markets Are Buying

The August edition of the Treasury International Capital (TIC) report released by the US Treasury Department, which contained data until June, was notable for one aspect in particular: China overtook Japan as the largest foreign investor in US Treasuries after a gap of eight months.

The Asian major had consistently been the largest foreign investor in US Treasuries before it lost the position to Japan in October 2016, as shown by the graph below. In the two year period plotted in the graph, China’s holdings had reached its nadir in November last year.

From June 2015 until November 2016, there were only three months in which the country added to its stock of US Treasuries. The decline over this period was equivalent to an annualized 12% pace. The sharpest decline was also seen in November, when the country sold securities worth $66 billion compared to the previous month.

From that point, except for January this year, China has been consistently adding to its stockpile, with the largest monthly addition of $44 billion seen in June.

However, this was not the only interesting trend in the report.

Trend among emerging markets

The graph below plots the holders of US Treasuries by country except China which had emerged most consistently in the top five over the last five years until the holdings data for June 2017. South Korea was excluded from this graph as Mexico had figured in the top five for three out of the five years considered in this analysis.

We’ve calculated the annualized rates of change in holdings over the past five years for these countries.

Brazil and Taiwan have seen nearly the same pace of change, but in opposite directions. While Brazil has seen its stockpile increase by a 1% annualized pace, Taiwan has seen a decrease at the same rate.

Mexico presents an interesting case. In terms of pace, it has seen the sharpest decline in its holdings at 9.7% annually. Its holdings of US Treasuries had peaked at $87.4 billion in April 2015 and now stand depleted to $32.3 billion – its lowest in these five years.

Russia has also offloaded US Treasuries quite sharply at an annual pace of 8% over the period. However, the difference between Mexico and Russia is that while Mexico had seen a peak in April 2015, Russia’s holdings had seen their nadir in the same month. Further, while Mexico continues to sell, Russia has been buying.

India has been piling in on US Treasuries of late. Its annual pace over the past five years stands at a staggering 17%. South Korea, has been adding to its US Treasuries holdings as well, at a similar pace of 16.8%.

In the next article, let’s look at what these holdings mean for emerging markets and what they may indicate for the future.

These Six Countries Hold 87% Of US Treasuries Amongst Emerging Markets

The US Treasury Department releases a report known as the Treasury International Capital (TIC) which breaks down the holding of securities – both foreigners holding US securities and US investors holding overseas securities.

The August 2017 edition of the report, which contained data as of June 2017, showed the following holding break-up between emerging markets and others.

A few caveats about the chart: Its comprised of only those emerging markets which were among the 34 nations individually outlined in the report. Thus, the remaining which were not outlined specifically, would be under the ‘others’ classification.

Also, we’ve restricted ourselves to the emerging markets universe as defined by MSCI and are not considering nations classified as ‘developing’ by the United Nations. This, thus leaves out countries such as Cayman Islands and Bermuda from our consideration as emerging markets.

What chunk of the overall pie?

The graph below details the percentage holding of the 12 emerging market countries whose holdings of US Treasuries were specified in the TIC report.

Of all the outstanding US Treasuries held by foreign countries, China owns a little less than one-fifth and is ahead of the pack by a proverbial mile. Brazil, the second largest investor in US Treasuries among emerging market nations, is a distant second, holding less than a twentieth of the total outstanding amount of $6.2 trillion.

The following graph illustrates this in absolute terms.

China, holding US Treasuries worth $1.1 trillion, towers above its emerging market peers. In fact, even if we were to consolidate the holdings of the 11 other individually identified emerging markets in the TIC report, it would not add up to China’s holding.

When looking at the entire universe of emerging markets holding US Treasuries, which amounts to $2.2 trillion, China’s share would be 51.7%.

The top five emerging markets – China, Brazil, Taiwan, India, and Russia, would account for 82.6% of all US Treasuries holdings in the emerging markets universe. All these countries hold over $100 billion in US Treasuries each. If we add the sixth largest holder among emerging markets – South Korea – to the mix, the percentage would go up to 87%.

There were also some interesting trends that came out of the report. We’ll look at these in the next article.