The Fed, in not raising rates this month, highlighted that it was worried by, and monitoring, “conditions abroad”.
That refocused traders’ attention on the Chinese and other emerging economies which have been under intense pressure lately from economic slowdown and, for many of the commodity producing nations, weak prices.
Michala Marcussen, Soc Gen’s global head of economics, says that has meant “global leverage has received much attention”.
Against the backdrop of generally weaker economic data for Asia and Latin America, and the on-going debate on Fed “lift-off”, leverage is once again centre stage and following up on a few requests we have updated our leverage clock (cf. charts below). Concerns are concentrated on the foreign currency denominated debt of non-financial corporations in emerging economies. Fear is that hedging is insufficient and notably for commodity producers. The latter point may even be adding to the commodities supply glut, as hard hit corporate are forced to produce more to meet debt obligations.
That sounds pretty ominous and clearly was worrying enough for the Fed to hold fire this month. The outlook might have darkened but, it’s not catastrophic Marcussen says. While she notes “imagining a full blown crisis is not hard”, and says Soc Gen recognises “the heightened downside risks”, she says a deep crisis is not around the corner.
Our expectation is that rather than deep crisis, a prolonged period of weaker growth awaits emerging economies, and not least China. Updating our leverage clock, our analysis suggests that the major EM economies have shifted significantly since 2011 and are now entering the “leverage bubble bust” phase (India, China, Brazil) and some have even tipped into outright deleveraging (Chile, Russia). Encouragingly, the bulk of the advanced economies are today better placed.
In the context of recent market ructions and acute bearishness around emerging markets, Marcussen could be seeing a light at the end of the volatility tunnel.
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