Developed market bonds are risk free by definition only, says Ashmore’s Dehn

Jan Dehn, Head of Research at Ashmore discusses in a Q&A the continued upturn in the global manufacturing cycle.

Why are the markets obsessed about current account deficits?

After all, Emerging Markets ought to be running current account deficits and importing capital to finance investment spending in order to further their economic convergence with richer countries. The reason is that current account deficits can also be a sign of domestic imbalances or a misaligned nominal exchange rate. For example, for too long Indonesia maintained a quasi-peg with the US dollar which was inconsistent with the pace of domestic demand. The result was a steady widening of the current account deficit and an accompanying steady loss of reserves. Thus domestic imbalances beget external imbalances. No economies are permanently in equilibrium. Modest domestic and external imbalances are the norm in developed and Emerging Markets alike.

PMIs in developed economies appear to be leading PMIs in Emerging Markets by about a month

Both the US and Japan had strong PMIs, while Europe’s PMIs were flat on aggregate for the month, though they remained above the 50 level, which signals expansion. In Emerging Markets, the manufacturing cycle recorded its second consecutive expansion in September. This upturn follows a particularly deep downturn in late 2012 and the first half of 2013. PMIs in developed economies appear to be leading PMIs in Emerging Markets by about a month in this particular cycle, so, in our view, it is reasonable to expect October to be another month of improvement in manufacturing.

The manufacturing cycle as an indicator of the broader business cycle

Despite the traditional role of the manufacturing cycle as an indicator of the broader business cycle we are sceptical about reading too much into capital spending dynamics from the current manufacturing cycle. Indeed, since 2008/2009, upturns in manufacturing cycles have repeatedly failed to turn into sustained capex led recoveries. Six years into the crisis, corporate cash levels remain high, and capex spending remains subdued.

What then, should we read into PMI cycles?

We think manufacturing cycles mainly reflect random shocks to demand and supply, or simply inventory corrections necessitated by inaccurate estimates of future final demand by purchasing managers. This means that the current pick up in the global manufacturing cycle is best regarded as a gentle and welcome tailwind, but not a development that is likely to unleash material and sustained changes in the global macroeconomic environment.

The impact of the US government shutdown on Emerging Markets

The shutdown of the US government has virtually no impact on Emerging Markets fundamentals, though there may be temporary effects on asset prices resulting from delays in data releases, etc. A failure to raise the debt ceiling – which has to be done by mid-October to avoid a default – would be far more serious, not least because Emerging Markets central banks are so heavily exposed to US Treasuries. The entire financial system, including its regulatory framework, is based on the assumption that US government debt is risk free. While a default would likely to be cured fairly quickly there would be costs beyond the initial dent to confidence. Borrowing costs for all Americans would probably rise. In an economy with debts in excess of 400% of GDP even modest increases in borrowing costs will hurt growth (as the collapse in mortgage applications over the summer showed). Fortunately, in the final equation, there is nothing that prevents the Fed from buying even defaulted securities. After all, it can just print some more money.


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