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Managing the Permanence of Spillovers
September, 2019
Alejandro Díaz de León Carrillo, Governor, Banco de México*
*/ The opinions/points of view herein stated are the author’s responsibility and do not necessarily represent the institutional view of Banco de México or its Governing Board.
INFORMACIÓN RESERVADA2
Recent Trends in Global Financial Markets and Spillovers to EMs2
Greater Integration of EMs with Global Financial Markets 1
Managing Global Spillovers: The Case of Mexico3
Managing the permanence of spillovers
Outline
INFORMACIÓN RESERVADA3
Stronger integration of EMs with Global Financial MarketsIn response to the 2008 financial crisis, central banks in AEs adopted an accommodative monetary policy,leading investors to a search for higher returns.
Advanced Economies: Reference Rates%
Source: Bloomberg.
Balance of Selected Central Banks as a Percentage of GDP%
Source: Bloomberg.
Managing the permanence of spillovers
September September
❶
INFORMACIÓN RESERVADA4
Significant portfolio recompositionAs a result of the search for higher returns, the participation of non‐resident investors in EMs assetsincreased.
Non‐residents’ Holdings of Government Bonds in Local Currency
As % of total outstanding debt
Note: Average by region of the percentage of ownership of local bonds denominated in local currency by foreigners from the following countries: Mexico, Peru, Colombia, Brazil, Indonesia, Malaysia, Thailand, Poland, Turkey, Israel, Russia, Hungary, South Africa and South Korea(enters since December2009).Source: Finance ministries, central banks and other national authorities.
Source: Banco de Mexico with EPFR data.
Equity and Fixed Income Flows Dedicated to Emerging Economies
Billions of dollars
2008 ‐ 2019 2019Fixed income 141,427 31,616
Equity 109,741 22,510‐ Total 251,168 9,105
Mexico becomes part of WGBI
Managing the permanence of spillovers
September
❷
INFORMACIÓN RESERVADA5
EMs have been strongly influenced by changes in global risk appetite and US interest ratesThe higher participation of international investors in emerging countries’ assets has increased theircorrelation, in particular, in episodes of high volatility.
Global Risk Aversion Index and EMBIIndex and basis points
The Citigroup Global Risk Aversion Index measures risk aversion across asset classes. It is an equally weightedindex of developed and emerging market sovereign spreads, US credit spreads, TED spread and implied FX,equity and swap volatility. The index is shown as standard deviations from the mean.Source: Central Bank of Mexico with Citi and Bloomberg data.
Emerging Markets Volatility and VIX IndexIndex
Note: The EM ETF volatility is the implied volatility of the EM ETF, the iShares MSCI Emerging Markets Index.Source: Central Bank of Mexico with Citi and Bloomberg data.
0
10
20
30
40
50
60
70
Aug‐11
Jan‐12
Jun‐12
Nov‐12
Apr‐13
Sep‐13
Feb‐14
Jul‐1
4
Dec‐14
May‐15
Oct‐15
Mar‐16
Aug‐16
Jan‐17
Jun‐17
Nov‐17
Apr‐18
Sep‐18
Feb‐19
Jul‐1
9
EM ETF volatility Index Volatility of the S&P 500 Index
Managing the permanence of spillovers
❸
INFORMACIÓN RESERVADA6Managing the permanence of spillovers
Outline
Recent Trends in Global Financial Markets and Spillovers to EMs2
Greater Integration of EMs with Global Financial Markets 1
Managing Global Spillovers: The Case of Mexico3
INFORMACIÓN RESERVADA7
Lower global growthTrade tensions have become a significant obstacle to global economic growth, with significant effects onmanufacturing production, investment and business confidence.
Global activity indicatorsAnnual % change, Index
Note: Annual change is calculated to the 3 month moving average of the world trade volume index and the industrial production volume index, both base 2010. ISM Manufacturing PMI is based on the report on business new orders SA. Source: CPB Netherlands, Bloomberg.
World GDP growthAnnual % change
Note: The calculations were used for the calculation of the second quarter. The sample of countriescalculated for the calculation represents 85.6% of the world GDP measured by purchasing power parity.Source: Central Bank of Mexico with Haver Analytics, JP Morgan and International Monetary Fund.
Managing the permanence of spillovers
❶
INFORMACIÓN RESERVADA8
Lower inflationary pressuresWith a softer outlook for growth, pressures have diminished for both headline CPI and core inflation.
1/ Refers to Personal Consumption Expenditure Deflator (PCE).Source: Haver Analytics, BEA, Eurostat and Statistics Bureau.
CoreHeadline
2/ Refers to Personal Consumption Expenditure Deflator, excluding food and energy (PCE).3/ Excluding fresh food, energy and the direct effect of an increase in consumption tax.Source: Haver Analytics.
Managing the permanence of spillovers
Consumer Price Index Annual % change
❷
9
Trend towards lower interest rates in AEsWith a weaker global economy and in the absence of inflationary pressures, markets have anticipated lower interest rates across the yield curve.
Source: BloombergSource: Bloomberg
10‐year Sovereign Bond Yields %
2‐year Sovereign Bond Yields%
‐1.0
‐0.5
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
Jan‐16
Apr‐16
Jul‐1
6
Oct‐16
Jan‐17
Apr‐17
Jul‐1
7
Oct‐17
Jan‐18
Apr‐18
Jul‐1
8
Oct‐18
Jan‐19
Apr‐19
Jul‐1
9
United States United KingdomJapan Eurozone
‐1.0
‐0.5
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
Jan‐16
Apr‐16
Jul‐1
6
Oct‐16
Jan‐17
Apr‐17
Jul‐1
7
Oct‐17
Jan‐18
Apr‐18
Jul‐1
8
Oct‐18
Jan‐19
Apr‐19
Jul‐1
9
United States United KingdomJapan Eurozone
Reference Rate and OIS Implied Trajectory%
Note: OIS is defined as the interest rate swap where the fixed rate is theeffective one day rate.**/ For the Federal Reserve, we use the federal funds rate midpoint ofrange (2.00%‐2.25%)Source: Banco de Mexico with Bloomberg data.
‐1.0%
‐0.5%
0.0%
0.5%
1.0%
1.5%
2.0%
2.5%
3.0%
Dec‐14 Dec‐15 Dec‐16 Dec‐17 Dec‐18 Dec‐19 Dec‐20 Dec‐21
Federal Reserve**ECB Deposit RateBank of CanadaBank of England
OIS implicit trajectory 5 Sep 2019
OIS implicit trajectory 31 Dec 2018
2018 2019 2020 2021
Managing the permanence of spillovers
Advanced Economies
❸
10
Short and long‐term interest rates in EMs have decreased, following the trend in AEsEMs fixed income markets have attracted capital inflows leading to a reduction in interest rates.
Source: Bloomberg.
10‐year Sovereign Bond Yields ofSelected Economies
%, 5‐day moving average
World Government Bond Index (WGBI) and 10 Year US Treasury
Index value in US dollars, %
Source: Citivelocity and Bloomberg.
‐30
0
30
60
90
J F M A M J J A S O N D
2011 2012 2013 2014 2015
2016 2017 2018 2019
Accumulated Fixed Income Flows to Emerging Markets Billions of US dollars
Source: EPFR.
Managing the permanence of spillovers
Decrease in In
dex Va
lue
Increa
se in
Inde
x Va
lue
❹
‐90
‐60
‐30
0
30
60
90
J F M A M J J A S O N D
2011 2012 2013 2014 2015
2016 2017 2018 2019
11
Accumulated Equity Flows to Emerging Markets Billions of US dollars
Source: EPFR.
Equity Markets in Advanced and Emerging EconomiesIndex Jan 2, 2018=100
Note: The graph presents the MSCI indices of developed and emerging economies (MSCI World Index andMSCI Emerging Market Index). The MSCI of emerging economies includes Mexico, Brazil, Chile, China,Colombia, Peru, Czech Republic, Egypt, Greece, Hungary, India, Indonesia, South Korea, Malaysia,Philippines, Poland, Qatar, Russia, South Africa, Taiwan, Thailand, Turkey and United Arab Emirates. TheMSCI of developed economies includes Australia, Austria, Belgium, Canada, Denmark, Finland, France,Germany, Hong Kong, Ireland, Israel, Italy, Japan, Holland, New Zealand, Norway, Portugal, Singapore,Sweden, Switzerland, United Kingdom United and United States.Source: Bloomberg
Story Count for “TRADE WAR” and Emerging Economies Currency Index
Index, Number of news
Note: The emerging economies currency index includes Peru, Philippines, Poland,Hungary, South Korea, South Africa, Russia, Brazil, Colombia, Chile, Malaysia, CzechRepublic, India and Mexico.Source: Central Bank of Mexico with Bloomberg data.
Uncertainty and volatility in global financial markets have had spillover effects on EMsPeriods of acute uncertainty and trade tensions have induced flight to quality episodes.
Managing the permanence of spillovers
❺
INFORMACIÓN RESERVADA12
Global risk appetite has had a strong influence on EMs financial marketsEven though an underlying trend of lower global interest rates has been present, trade tensions andvolatility episodes have affected EMs.
Note: Interest rates correspond to swap rates for a term of 2 and 10 years, respectively. Only the cases of Argentina and Peru use the rates of government bonds of 3 and 10years.Source: Bloomberg.
CurrenciesPercentage
Stock indicesPercentage
10Y Interest ratesBasis points
Latin
America
Emerging
Europ
e an
d Afric
aEm
erging
Asia
Performance from Jan 1st, 2019 to Jul 31th, 2019
Latin
America
Emerging
Europ
e an
d Afric
aEm
erging
Asia
CurrenciesPercentage
Stock indicesPercentage
10Y Interest ratesBasis points
Performance from Aug 1st, 2019 to Sep 6th, 2019
Managing the permanence of spillovers
‐10 ‐5 0 5 10
Mexico
Brazil
Chile
Colombia
Peru
Russia
Poland
Turkey
Hungary
Czech Republic
South Africa
South Korea
Malaysia
India
Philippines
Thailand
Indonesia
‐20 ‐10 0 10 20 ‐200 ‐100 0 100 200 ‐10 ‐5 0 5
Mexico
Brazil
Chile
Colombia
Peru
Russia
Poland
Turkey
Hungary
Czech Republic
South Africa
South Korea
Malaysia
India
Philippines
Thailand
Indonesia
‐10 ‐5 0 5 10 ‐100 0 100
❻
INFORMACIÓN RESERVADA13Managing the permanence of spillovers
Outline
Recent Trends in Global Financial Markets and Spillovers to EMs2
Greater Integration of EMs with Global Financial Markets 1
Managing Global Spillovers: The Case of Mexico3
INFORMACIÓN RESERVADA14
Note: The null hypothesis for the structural change test is that the average exchange rate is the same before and after the structural change. The test concludes thatthere are five structural breaks on the dates indicated in the figure at the 5% significance level. The associated F statistic is 307.78 with a critical value of 12.97. Themodel is estimated with information from January 1, 1997 to August 28, 2019. Prepared with information from Banco de México.
10
11
12
13
14
15
16
17
18
19
20
21
22
23
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
Oct‐07‐2008
May‐05‐2017
Exchange RatePesos per dollar
Jan‐29‐2015
The Mexican economy has faced a sequence of adverse shocks since mid‐2014 that required a real exchangerate adjustmentA reduction of external sources of finance has required a lower current account deficit. This process has alsofaced a recomposition of the external accounts.
Managing the permanence of spillovers
❶
15
Recomposition of external accountsThe trade balance has reversed its medium‐term trends, with a recent oil‐trade deficit and a non‐oil trade surplus.
Trade BalanceMillions of dollars
Current Account% of GDP
Source: SAT, SE, Banco de México, INEGI. Merchandise Trade Balance. SNIEG. Information of National Interest.
‐10.000
‐8.000
‐6.000
‐4.000
‐2.000
0
2.000
4.000
6.000
8.000
10.000
12.000
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
Q2 2019
Non‐oil
Oil
Total
‐5
‐4
‐3
‐2
‐1
0
1
2
2012
2013
2014
2015
2016
2017
2018
2019
Source: Banco de México and INEGI.
Q2 2019
Annual data
Current account
‐1.6
‐2.5
‐1.9
‐2.6‐2.3
‐1.7 ‐1.8
Managing the permanence of spillovers
❷
70
80
90
100
110
120
130
140
150
160
170
180
190
200
1978
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
2016
2018
‐50
0
50
100
150
200
250
300
1978
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
2016
2018
16
Bilateral Real Exchange Rate between Mexico and the United States
Index 1992=100
General Inflation and Nominal Depreciation RateAnnual % change
Source: Bureau of Labor Statistics, Banco de México and INEGI. Source: Banco de México and INEGI.
An orderly adjustment of the real exchange rate has taken place
Depreciation July
Headline Inflation
Exchange rate depreciation
2019
August
Managing the permanence of spillovers
1F August
❸In spite of the significant real exchange‐rate depreciation of the last years, the pass‐through of theexchange rate to prices remains at reduced levels, reflecting an improved functioning of the economy’snominal system.
INFORMACIÓN RESERVADA17
Mexican financial markets have been affected by external and domestic risk factorsThe exchange rate and the credit default swap (CDS) have traded with a premium.
Dollar‐Peso Exchange Rate and Synthetic PesoPesos per dollar
Note: The synthetic peso is estimated taking into account the following effects: Dollar,risk aversion, energy, emerging currencies and rate differential adjusted for Mexico’svolatility. The dollar effect is calculated with the Euro, Sterling, Australian dollar andNew Zealand dollar. The energy is built with the Bloomberg Energy Index (BloombergEnergy Subindex). The effect of emerging currencies is calculated with the Brazilian real,the Colombian peso, the Chilean peso and the South African rand. The decomposition isdone by linear regressions.Source: Calculations by Banco de México with information from Bloomberg.
Cost of Hedging Sovereign Credit Risk Measured by the CDS of Debt Issued in USD by Mexico and
Other Countries Rated BB and BBB 1/Basis points
Note: 2/ The CDS basket was constructed using an average of the five‐year CDS daily data from Brazil, Colombia, South Korea, Turkey, Chile, Russia and South Africa.Sources: Bank of Mexico with data from Bloomberg.
Mexico CDS vs CDS from a Basket of Emerging Countries2/
Basis points
SpreadBasis points
1/ EME countries considered in the BBB+ range: Peru and Thailand. EME countriesconsidered in the BBB range: Philippines and Indonesia. EME countries considered in theBBB‐ range: Russia and Colombia. Countries considered in the BB range: Brazil and SouthAfrica. The average is equally weighted and is computed using the CDS of countries withthe same sovereign credit rating. The minimum corresponds to the minimum creditrating assigned by the three major credit rating companies (S&P, Moody's and Fitch).Source: Bloomberg.
Managing the permanence of spillovers
Sep 2ndSeptember
❹
‐50
0
50
100
150
200
250
300
350
400
450
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
Other non‐sovereign debtInflation‐linked sovereign debt and Bank of Mexico securitiesFixed‐rate sovereign debtZero‐coupon sovereign debtEquityFX Net Position
Macroeconomic policies need to consider global and local risk factorsGiven the degree of openness of the capital account in Mexico, the country needs to remain an attractive investment destination.
Foreign Investors’ Position in Securities Denominated in Mexican Pesos
Billions of dollars
Spread between Emerging Markets Interest Rates and United States Interest Rates Adjusted by Volatility
(3 months)Index
Source: Banco de Mexico, Indeval and CME. 1/ Selected countries are Brazil, Chile, Colombia, Turkey, South Africa, South Korea and Poland.Source: Bloomberg with calculations from Banco de Mexico.
Managing the permanence of spillovers
August‐0,3‐0,2‐0,10,00,10,20,30,40,50,60,70,80,91,01,11,21,31,4
2014
2015
2016
2017
2018
2019
Range
Emerging Markets average 1/Mexico
September
18
Carry to Risk
❺
19
19
One‐year Ahead Implied1/ Distribution of Mexican Peso Annual Returns
Density
1/ The implied distribution functions for FX, Fixed Income and Total Return securities are obtained using the Breeden‐Litzenberger methodology, the Ho‐Lee model, and a Copula model that combines the first two, respectively.Source: Bank of Mexico with data from Bloomberg.
Distribution of Returns of Mexican Assets
One‐year Ahead Implied1/ Distribution of Mexican Government Bonds Annual Returns
Density
One‐year Ahead Implied1/ Distribution of Mexican Government Bonds Annual Returns
with FX ExposureDensity
‐35% ‐25% ‐15% ‐5% 5% 15% 25% 35%
Jun‐14 Sep‐19
‐35% ‐25% ‐15% ‐5% 5% 15% 25%
Jun‐14 Sep‐19
‐15% ‐10% ‐5% 0% 5% 10% 15% 20% 25%
Jun‐14 Sep‐19
Managing the permanence of spillovers
Jun 30, 2014 Sep 4, 2019 Jun 30, 2014 Sep 4, 2019 Jun 30, 2014 Sep 4, 2019
Mean Volatility CVaRJun 30, 2014 ‐2.6% 9.7% 24.5%Sep 04, 2019 ‐4.0% 9.2% 25.3%
Mean Volatility CVaRJun 30, 2014 3.1% 4.3% 5.5%Sep 04, 2019 7.4% 4.2% 1.0%
Mean Volatility CVaRJun 30, 2014 0.0% 9.8% 21.7%Sep 04, 2019 2.8% 9.6% 18.9%
❻
‐1,0
‐0,5
0,0
0,5
1,0
1,5
2,0
‐1
0
1
2
3
4
5
6
7
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
20Managing the permanence of spillovers
Term premium in the 10‐year peso bonds is strongly correlated with the “risk‐taking” channelof US monetary policy and US interest rates.
10‐year Average Term Premium and 10‐year U.S. Treasury Yield%
‐1
0
1
2
3
4
5
6
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
México:10‐year term premium
U.S.:10‐year term premium1/
1/ Data for U.S. term premium is estimated using Kim and Wright (2005) method with data from the FRED.Source: Banco de México with data from Valmer, FRED and Bloomberg. See Banco de México (2019). “Evolution of the Mexican term premium”, in Box 5 of Banco de México’s Quarterly Report April ‐ June 2019, pp. 69‐73.
México:10‐year term premiumCDS and other factors
U.S.: 10‐year treasury yield
❼
INFORMACIÓN RESERVADA21
EMs are more integrated to global financial markets. This entails challenges andopportunities. Open capital accounts can bring much needed resources for growth and development and promote developing
financial markets.
Recipient economies need strong and resilient macroeconomic fundamentals.
It is essential to bolster the resilience of the financial system to outflows: a stable domestic financial system andsound borrower balance sheets may help reduce both the likelihood and the impact of flow reversals.
Deeper financial markets with a strong domestic investor base could help offset selling pressures from volatileglobal risk appetite.
Systemic economies´ central banks have to consider spillback effects of their actions.
Transparent policy processes and clearly communicated actions can reduce the risk of market and capital flowvolatility. Managing financial markets expectations has become even more critical.
We are facing a polarized environment in both AEs and EMs. Short‐term policies have been adopted, puttingpolitical pressure on multilateral and domestic institutions.
Much needed structural reforms and adequate long‐term policies have been absent in several of our countries,while escalating geopolitical and trade tensions have put additional pressure on central banks’ aggregatedemand management responsibilities, increasing the challenges and trade‐offs of monetary policy.
Conclusions, Challenges and Opportunities
Managing the permanence of spillovers