Emerging markets are supported by central bank actions and valuations

Global markets have reacted to the coronavirus pandemic by building in a risk premium to reflect the deterioration in underlying growth and solvency assumptions. Emerging markets (EM), in particular, have built in a risk premium based on funding stresses that have become evident in US dollar markets.

The initial reaction to the global economic “sudden stop” was to build in a risk premium commensurate with the information available at the time. Risk aversion resulted in the strengthening of funding currencies, such as the euro and yen, relatively stable EM rates and some weakening in EM credit. As the scope of the crisis became evident, starting in Italy and then ripping through Europe and the US, funding pressures in the US dollar market emerged, first in the US Treasury market, then in European government bonds, followed by US money markets and ultimately every aspect of financial markets. Because US dollar assets are the largest component of global markets, this pressure inevitably showed up in foreign exchange markets, where it became very difficult to borrow US dollars in the forward market. The seizing up of the currency markets had a dramatic impact on EM currencies and rates.

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