Market liquidity and emerging market local currency sovereign bonds Hyun Song Shin* Bank for International Settlements NBB-ECB conference on Managing financial crises: the state of play Brussels, 6 November 218 * The views expressed here are mine, not necessarily those of the Bank for International Settlements.
Two structural developments since 199s EME crises Dollar intermediation has shifted from banks to the bond market Local currency sovereign bond markets have matured EMEs better placed to meet challenges But have not insulated them completely from global conditions 2
From banks to bond markets 3
Non-resident holdings of local currency sovereign bonds 4 3 2 1 4 Peru South Africa Indonesia Mexico Poland Russia Malaysia Colombia Egypt Turkey Romania Hungary Thailand Brazil Chile Lithuania Latvia Philippines India China Bulgaria Ukraine 216 Q4 217 Q4 Source: World Bank
Two duration measures Duration = / Compare duration measures with: Percentage return in local currency terms Percentage return in dollar terms 5
Percentage return Yield change 6
EME bond fund local currency returns and USD returns Sources: EPFR; JPMorgan Chase; Hofmann, Shim and Shin (217) 7
EME bond fund local currency returns and USD returns When local currency bond yields fall, gains to dollar-based investors magnified by EME currency appreciation Sources: EPFR; JPMorgan Chase; Hofmann, Shim and Shin (217) 8
EME bond fund local currency returns and USD returns When local currency bond yields rise, losses to dollar-based investors magnified by EME currency depreciation Sources: EPFR; JPMorgan Chase; Hofmann, Shim and Shin (217) 9
EMEs local currency sovereign bonds performance 1, January 213 October 218 Indonesia Brazil y = -.9-6.6x where R 2 =.6 y = -.1-4.52x where R 2 =.88 1.5..5 1. Change in yield, in percentage points US dollar return 5 5 Return, in percent y = -.11-8.52x where R 2 =.66 y =.4-4.34x where R 2 =.93 1.5..5 1. Change in yield, in percentage points US dollar return 5 5 Return, in percent 1 Total return on bonds denominated in local currency as weekly change in JPMorgan GBI-EM principal return index in local currency and US dollar. Sources: JPMorgan Chase; BIS calculations. 1
EMEs local currency sovereign bonds performance 1, January 213 October 218 Mexico South Africa y = -.6-12.4x where R 2 =.58 y = -.1-5.5x where R 2 =.88 1.5..5 1. Change in yield, in percentage points Local currency return 5 5 Return, in percent y = -.2-12.8x where R 2 =.7 y =.3-4.59x where R 2 =.94 1.5..5 1. Change in yield, in percentage points US dollar return 5 5 Return, in percent 1 Total return on bonds denominated in local currency as weekly change in JPMorgan GBI-EM principal return index in local currency and US dollar. Sources: JPMorgan Chase; BIS calculations. 11
Advanced economies sovereign bond indices 1, January 213 October 218 France y = -.6-2.67x where R 2 =.2 y = -.3-5.41x where R 2 =.96.2.1..1.2.3 Change in yield, in percentage points Local currency return 2 2 4 Return, in percent Sweden y = -.12-1.91x where R 2 =.1 y = -.3-5.9x where R 2 =.94.2.1..1.2.3 Change in yield, in percentage points US dollar return 2 2 4 6 Return, in percent 1 GBI Global Country 5 to 7 year maturity indices for the selected economies. Sources: JPMorgan Chase; BIS calculations. 12
Yields of local currency EM government bonds and the exchange rates 1 Yields 2 Volatility of yields 3 The exchange rate 4 Per cent 21=1 1 All three graphs show the simple average of Brazil, India, Indonesia, Malaysia, Mexico, the Philippines, Poland and South Africa. The black vertical lines correspond to 15 April 218. 2 Yields on 5-year local currency bonds. 3 18-day moving standard deviation of daily changes in yields. 4 In dollars per unit of local currency. Sources: Bloomberg; national data; BIS calculations. 13
Du-Schreger spread Du and Schreger (JF 215) Consider a dollar-based investor Swap dollars into pesos Invest in peso sovereign bonds Du-Schreger spread = peso bond yield on swapped basis same maturity US treasury yield Du-Schreger spread is risk premium on local currency sovereign bond for a dollar-based investor Du-Schreger spread is high when the dollar is strong Hofmann, Shim and Shin (216) 14
Exchange rates and credit conditions Conventionally, exchange rates enter through Exchange rate pass-through to inflation Net exports Financial channel of exchange rates Operates through financial intermediaries Appreciation loosens domestic credit conditions 15
Annual growth rates of dollar loans and bonds together with broad USD index Annual growth in % 2 1 1 23 24 25 26 27 USD-denominated cross-border bank lending to non-us residents 28 29 21 211 212 International US dollar bonds issued by EME non-financial corporations 1 213 214 215 216 217 2 218 Broad USD index ( USD depreciation) Source: BIS locational banking statistics and nominal effective exchange rate indices. 16