- ASX SPI 200 futures down 0.3% to 6,345.00
- Dow Average down 0.1% to 29,888.78
- Aussie down 1.8% to 0.6921 per US$
- U.S. 10-year yield rose 3.0bps to 3.2256%
- Australia 3-year bond yield rose 13bps to 3.63%
- Australia 10-year bond yield rose 14bps to 4.13%
- Gold spot down 1.0% to $1,839.39
- Brent futures down 5.6% to $113.12/bbl
Pockets of outperformance are starting to pop up in emerging markets even as the Federal Reserve’s most aggressive rate hike in two decades roils assets around the world.
Losses in developing markets have so far been smaller than in the US during a wide-reaching rout that saw the worst Treasuries collapse in at least half a century. Corporate bonds from emerging nations are proving to be more resilient than US high-yield debt and stocks are up to a three-month high relative to their counterparts in the S&P 500 Index.
It sounds counterintuitive: Risk assets are typically hammered during market volatility and emerging markets have indeed been hurt, with a key gauge of equities fresh off its worst week since March. But with much of that turbulence stemming from assets in the US — the world’s defacto safe haven — amid mounting concerns about the growth outlook there, the relative appeal of developing nations is growing.
“The negative market view toward emerging markets will be relatively short-lived,” said Lewis Jones, emerging-market debt portfolio manager at William Blair Investment Management LLC in New York. “We expect the emerging market-developed market growth differential to widen as the US slips closer to recession.”
Emerging markets have so far staved off a full-on repeat of the Taper Tantrum of 2013, when vulnerabilities led to intense market volatility. This time around, central bankers from emerging markets have been ahead of the curve in paring back pandemic-era stimulus, while storing away more in foreign currency reserves.
Among the 16 major currencies tracked by Bloomberg, the year’s only two to gain come from the developing world: Brazil’s real and Mexico’s peso. Currencies from mature economies — the yen and Norwegian krone — lead losses in the group.
As a selloff in US high-yield corporate bonds deepens, more than doubling the average yield in the past year, emerging-market corporate debt is witnessing smaller losses. Their relative resilience has taken the spread between emerging markets and US high yield from a premium to a discount this year. Now developing-nation bonds are offering the least yield since November 2020, in relative terms.
The outperformance is extending to corners of the stock market, too. The MSCI Emerging Markets Index, which plunged 32% between February 2021 and May 2022, is down less than its US equities this year. That took developing-nation stocks to the highest level in three months relative to US equities last week.
For Nordea Investment, there’s also opportunity hiding in emerging markets if fears of a US recession align with cooling inflation and the Fed starts easing off its hawkish path.
“Patience is a virtue,” Witold Bahrke, a Copenhagen-based senior macro strategist at Nordea Investment, said in an interview. “We do need to see a less hawkish Fed to trigger a turnaround.”
As gasoline prices soar and the US considers invoking Cold War-era laws to boost production, there’s a massive pool of oil refining capacity on the other side of the Pacific Ocean that’s sitting idle.
Around a third of Chinese fuel-processing capacity is currently out of action as Asia’s largest economy struggles to put the coronavirus behind it. If tapped, the extra supply of diesel and gasoline could go a long way to cooling red-hot global fuel markets, but there’s little chance of that happening.
That’s because China’s refining sector is set up mainly to serve its mammoth domestic market. The government controls how much fuel can be sent abroad via a quota system that also applies to privately owned companies. And while Beijing has allowed more shipments at times over the years, it doesn’t want to become a major oil-product exporter as that would run counter to its goal of gradually de-carbonizing the economy.
“China’s absence in the export market is keenly felt in the broader regional, and even global market,” said Jane Xie, a senior oil analyst at data and analytics firm Kpler. There’s been a massive expansion in refining capacity in the country over the last three to five years, but that hasn’t really translated into increased oil-product exports, she said.
The contrast between China and the US — where refineries in some areas are running at close to full capacity — reflects a tectonic shift in the industry over the last few years. European and North American plants have been shutting down, a trend that was accelerated by Covid-19, while most new facilities are being built in the developing world, particularly Asia and the Middle East.
In China, many of the new plants are so-called mega-refineries, which have the flexibility to produce both fuels and petrochemicals. The rapid growth means the country may already be the world’s biggest refiner. It had 17.5 million barrels a day of capacity at the end of 2020, and will reach 20 million by 2025, according to China National Petroleum Corp.’s Economics & Technology Research Institute. The US, by contrast, had 18.14 million barrels a day of capacity in 2020, the latest data from BP Plc show.
China’s big state-owned refiners, which make up around three-quarters of the industry, were running at around 71% of capacity on June 10, according to CITIC Futures Co. The private processors, known as teapots, were operating at just 64%, it said. Most of these companies, many of which are in Shandong province, aren’t allowed to export any fuel at all.
Even in relatively normal times, China doesn’t send a lot of oil products abroad. Last year, for example, it shipped around 1.21 million barrels a day of fuel oil, diesel, gasoline and jet fuel, customs data show. That’s only around 7% of its total refining capacity at the end of 2020.
And this year, rather than allow more shipments as local demand drops, it’s doing the opposite. Only 17.5 million tons of fuel export quotas have been allocated so far, compared with 29.5 million tons at the same point last year.
In the regional oil hub of Singapore, the profit from turning oil into dieselhas surged to above $60 a barrel from around $10 at the beginning of the year. That translates to a potential windfall of as much as $372 a ton that Chinese refiners are missing out on, according to local industry consultant OilChem.
Beijing’s unwillingness to ramp up fuel output and act as a swing producer in times of global shortages is being felt by everyone from US motorists facing pain at the pump to European factories bidding for scarce diesel cargoes. But the most detrimental impacts are in China’s Asian neighbors, in countries like Sri Lanka and Pakistan where fuel shortages are crippling their economies.