managing the permanence of spillovers · managing the permanence of spillovers september, 2019...

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


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.


September September

❶


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


September

❷


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


❸

INFORMACIÓN RESERVADA6Managing the permanence of spillovers

Outline





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.


❶


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.


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


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.


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.


❺


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


‐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





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.


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


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


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.


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.


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.


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


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


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 · managing the permanence of spillovers september, 2019...

Documents