Coronavirus breaks out beyond China: the implications for emerging-market debt

The scope of the coronavirus outbreak has escalated over the past week from a regional outbreak to potentially becoming a global pandemic, with the World Health Organization saying the majority of new cases are now outside of China.

Risk assets moved lower after the Centers for Disease Control and Prevention (CDC) press conference on Tuesday, where officials noted it’s not a matter of if, but a question of when the virus will spread in the United States, adding that a global pandemic is likely. The director of the CDC later assured, however, that steps taken by the United States to contain the virus have worked and that the country is well prepared to deal with an outbreak.¹

The fallout has sent U.S. Treasury yields to record lows, and the market is pricing in about 75 basis points of rate cuts from the U.S. Federal Reserve (Fed) over the next year.² The potential for a broader disruption in economic activity—and global growth—looks increasingly likely, and supply chain ramifications could be sizable and global in nature.

Global growth expectations have already been revised lower, and the overall expectation is for a gradual recovery to take place during the second and third quarters of the year instead of initial estimates for a sharp V-shaped recovery.

In the past weeks, concerns about the impact of the outbreak have evolved from a demand shock to a broader supply shock as a result of the interruption to the supply chain—mainly in the auto segment (e.g., South Korea, Japan)—and to some extent pharmaceuticals, electronics, and the broad manufacturing sector.

Expectations of continued monetary policy support by G3 central banks³ are now complemented by calls for expansionary fiscal policy measures. But there appears to be limited scope for immediate action among G3 economies—the United States is gearing up for its presidential election in November, the European Union continues to be mired by a lack of political agreement over many issues, and Japan looks overextended (from a debt perspective).

In our view, caution is warranted in emerging markets, primarily in segments of the asset class with lower levels of participation by crossover buyers. Examples include areas such as noninvestment sovereign credits, distressed situations (e.g., Argentina, Ecuador, and Lebanon), and select Asia high-yield credits (given their high refinancing needs that can make them reliant on a market that's become less accommodative to new issues than before).

That said, technicals remain supportive for the broader asset class, with aggregate refinancing needs for both sovereign and corporate credits remaining limited in 2020. The first quarter of the year saw a significant amount of maturities and coupon payments, while supply has been limited since the end of January.

While it’s still impossible to assess the true economic cost of the outbreak, the ongoing repricing of risk in the markets could ultimately lead to opportunities, especially for those with a longer investment horizon. Until then, caution and selectivity will remain the order of the day.

1 “CDC official warns Americans it's not a question of if coronavirus will spread, but when,” CNN.com, February 2020. 2 Bloomberg, as of February 2020. 3 G3 central banks refer to the U.S. Federal Reserve, the Bank of Japan, and the European Central Bank. G3 economies refer to the United States, Japan, and the eurozone.