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 playBrussels, 6 November 2018

* The views expressed here are mine, not necessarily those of the Bank for International Settlements.

Two structural developments since 1990s 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

4

Non-resident holdings of local currency sovereign bonds

40

30

20

10

0

Per

u

Sou

th A

fric

a

Ind

on

esia

Mex

ico

Po

lan

d

Ru

ssia

Mal

aysi

a

Co

lom

bia

Egyp

t

Turk

ey

Ro

man

ia

Hu

ng

ary

Thai

lan

d

Bra

zil

Ch

ile

Lith

uan

ia

Latv

ia

Ph

ilip

pin

es

Ind

ia

Ch

ina

Bu

lgar

ia

Ukr

ain

e

2016 Q4 2017 Q4

Source: World Bank

5

Two duration measures

Duration = − / Compare duration measures with:

Percentage return in local currency terms Percentage return in dollar terms

6

Percentagereturn

Yield change0

EME bond fund local currency returns and USD returns

Sources: EPFR; JPMorgan Chase; Hofmann, Shim and Shin (2017)

7

EME bond fund local currency returns and USD returns

Sources: EPFR; JPMorgan Chase; Hofmann, Shim and Shin (2017)

When local currency bond yields fall, gains to dollar-based investors magnifiedby EME currency appreciation

8

EME bond fund local currency returns and USD returns

Sources: EPFR; JPMorgan Chase; Hofmann, Shim and Shin (2017)

When local currency bond yields rise, losses to dollar-based investors magnified by EME currency depreciation

9

10

EMEs local currency sovereign bonds performance1, January 2013 – October 2018

1Total 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.

Indonesia Brazil

y = -0.09 -6.6xwhere R2 = 0.60

y = -0.01 -4.52xwhere R2 = 0.88

–10

–5

0

5

–0.5 0.0 0.5 1.0

US dollar return

Change in yield, in percentage points

Retu

rn, i

n pe

rcen

t

y = -0.11 -8.52xwhere R2 = 0.66

y = 0.04 -4.34xwhere R2 = 0.93

–10

–5

0

5

–0.5 0.0 0.5 1.0

US dollar return

Change in yield, in percentage points

Retu

rn, i

n pe

rcen

t

11

EMEs local currency sovereign bonds performance1, January 2013 – October 2018

1Total 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.

Mexico South Africa

y = -0.06 -12.4xwhere R2 = 0.58

y = -0.01 -5.05xwhere R2 = 0.88

–10

–5

0

5

–0.5 0.0 0.5 1.0

Local currency return

Change in yield, in percentage points

Retu

rn, i

n pe

rcen

t

y = -0.02 -12.8xwhere R2 = 0.70

y = 0.03 -4.59xwhere R2 = 0.94

–10

–5

0

5

–0.5 0.0 0.5 1.0

US dollar return

Change in yield, in percentage points

Retu

rn, i

n pe

rcen

t

12

Advanced economies sovereign bond indices1, January 2013 – October 2018

1 GBI Global Country 5 to 7 year maturity indices for the selected economies.

Sources: JPMorgan Chase; BIS calculations.

France Sweden

y = -0.06 -2.67xwhere R2 = 0.02

y = -0.03 -5.41xwhere R2 = 0.96

–4

–2

0

2

–0.2 –0.1 0.0 0.1 0.2 0.3

Local currency return

Change in yield, in percentage points

Retu

rn, i

n pe

rcen

t

y = -0.12 -1.91xwhere R2 = 0.01

y = -0.03 -5.09xwhere R2 = 0.94

–6

–4

–2

0

2

–0.2 –0.1 0.0 0.1 0.2 0.3

US dollar return

Change in yield, in percentage points

Retu

rn, i

n pe

rcen

t

13

Yields of local currency EM government bonds and the exchange rates1

1 All three graphs show the simple average of Brazil, India, Indonesia, Malaysia, Mexico, the Philippines, Poland and South Africa. The blackvertical lines correspond to 15 April 2018. 2 Yields on 5-year local currency bonds. 3 180-day moving standard deviation of daily changes inyields. 4 In dollars per unit of local currency.

Sources: Bloomberg; national data; BIS calculations.

Yields2 Volatility of yields3 The exchange rate4

Per cent 2010=100

14

Du-Schreger spread

Du and Schreger (JF 2015) 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 (2016)

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

16

Annual growth rates of dollar loans and bonds together with broad USD index

Annual growth in %

Source: BIS locational banking statistics and nominal effective exchange rate indices.

20

10

0

–10

–202018201720162015201420132012201120102009200820072006200520042003

bank lending to non-US residentsUSD-denominated cross-border International US dollar bonds issued

by EME non-financial corporations1Broad USD index (↓ USD depreciation)