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About Defaults - Russia and More?

May 25, 2022

Read Time 2 MIN


U.S. Treasury closes the debt payment loophole for Russia. EM central banks keep an eye on the policy rate differential with the U.S. Fed.

Russia Sovereign Default

The U.S. Treasury closed the loophole (a special Office of Foreign Assets Control (OFAC) waiver) that allowed U.S. banks and individuals to receive bond payments from the Russian government. With Russia’s technical default looming, some commentators argued that this creates an international precedent that can complicate the lives of sovereign borrowers down the road. An aspect that might be more relevant in the near-term is the impact on Russia’s corporate debt, which is several orders of magnitude larger than sovereign debt. Yes, it is not huge as percentage of GDP, and it is very concentrated in several sectors, but broken financing and supply chains will push Russia’s potential growth trajectory lower in the coming years.

Frontier EM Spreads, Default Risks

Russia is not the only emerging markets (EM) where the default drumbeat is getting louder. Several low-income (or frontier) EMs are either in distressed territory or getting close, being hit by exogenous shocks and rising global rates. The current EM High Yield spread (J.P. Morgan’s EMBIG Diversified HY Index) is the widest since 2002/03 (with the exception of the global financial crisis and the pandemic crisis – see chart below). By contrast, EM Investment Grade spread (J.P. Morgan’s EMBIG Diversified IG Index) is still close to historic lows. Of course, individual countries’ circumstances are different (EM is not a monolith), but if the current trends continue, we expect to hear more calls to extend the G20 Common Framework for debt treatment. From the investment perspective, it is also important that several countries in this group are talking to the IMF about new programs and loans – disbursements and news about structural reforms tend to improve sentiment and compress spreads.

EM Central Banks And U.S. Fed Decoupling

And talking about rising global rates, the U.S. Federal Reserve’s (Fed’s) minutes will be scrutinized this afternoon for signs of either confirming the +50bps pace of rate hikes or perhaps expanding it to +75bps. It’s not just “we the market” who are watching the Fed – many EM central banks do the same (despite being way ahead in the current tightening cycle). Mexico’s deputy governor, Jonathan Heath, said yesterday that they cannot decouple from the Fed and might need to widen the policy rate differential in order to maintain restrictive stance. Stay tuned!

Chart at a Glance: “Fragile” EM Spreads Are Widening

Chart at a Glance: “Fragile” EM Spreads Are Widening

Source: Bloomberg LP

PMI – Purchasing Managers’ Index: economic indicators derived from monthly surveys of private sector companies. A reading above 50 indicates expansion, and a reading below 50 indicates contraction; ISM – Institute for Supply Management PMI: ISM releases an index based on more than 400 purchasing and supply managers surveys; both in the manufacturing and non-manufacturing industries; CPI – Consumer Price Index: an index of the variation in prices paid by typical consumers for retail goods and other items; PPI – Producer Price Index: a family of indexes that measures the average change in selling prices received by domestic producers of goods and services over time; PCE inflation – Personal Consumption Expenditures Price Index: one measure of U.S. inflation, tracking the change in prices of goods and services purchased by consumers throughout the economy; MSCI – Morgan Stanley Capital International: an American provider of equity, fixed income, hedge fund stock market indexes, and equity portfolio analysis tools; VIX – CBOE Volatility Index: an index created by the Chicago Board Options Exchange (CBOE), which shows the market's expectation of 30-day volatility. It is constructed using the implied volatilities on S&P 500 index options.; GBI-EM – JP Morgan’s Government Bond Index – Emerging Markets: comprehensive emerging market debt benchmarks that track local currency bonds issued by Emerging market governments; EMBI – JP Morgan’s Emerging Market Bond Index: JP Morgan's index of dollar-denominated sovereign bonds issued by a selection of emerging market countries; EMBIG - JP Morgan’s Emerging Market Bond Index Global: tracks total returns for traded external debt instruments in emerging markets.

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