Further contributing to the uptick in 10-year government bond yields in some emerging East Asian markets was a downgrade of the sovereign rating outlook by major rating agencies. In April, S&P Global downgraded Indonesia’s sovereign rating outlook to negative from stable and Thailand’s from positive to stable. Fitch Ratings revised downward its sovereign rating outlook for Viet Nam from positive to stable in April. As the COVID-19 pandemic halted economic activities globally, all emerging East Asian economies posted much lower growth rates (or contractions) in the first quarter (Q1) of 2020, with the growth outlook expected to further decline in the second and third quarters of the year
Advanced economies have been among the hardest hit economies globally. Between 28 February and 29 May, all major advanced economies adopted easing monetary stances and introduced fiscal stimulus schemes to mitigate the negative impact of COVID-19 on the economy. In the US, the Federal Reserve deviated from its original course after leaving the policy rate unchanged at its January meeting. As risks from the continued spread of COVID-19 heightened, the Federal Reserve announced an emergency rate cut of 50 bps in the federal funds rate on 3 March, which was well before the regularly scheduled Federal Open Market Committee monetary policy meeting on 17–18 March.
Citing the negative impact of COVID-19 containment efforts on consumer sentiment and behavior, as well as the economy, the Federal Reserve reduced the federal funds rate by an additional 100 bps to between 0% and 0.25% on 15 March. In addition to interest rate cuts, the Federal Reserve also implemented measures to ease financial turmoil caused by COVID-19, including purchasing additional assets of at least USD500 billion and facilitating credit to households and businesses via a reduction in the primary credit rate at its discount window. On 17–18 March, the Federal Reserve established lending facilities for commercial paper, money markets, and primary credit dealers to ease funding demands and improve market liquidity. The Federal Reserve also engaged in coordinated actions with other central banks such as the Bank of Canada, Bank of Japan (BOJ), European Central Bank (ECB), and Swiss National Bank to provide liquidity via US dollar swap lines by reducing the rates charged.
US economic data warranted the Federal Reserve’s concern. Gross domestic product (GDP) contracted 5.0% year-on-year (y-o-y), based on a revised estimate, in Q1 2020 after gaining 2.1% y-o-y in the previous quarter. Labor markets were also hit hard, with the unemployment rate soaring to 14.7% in April from 4.4% in March. Nonfarm payrolls showed a reduction of 20.7 million jobs in April, following a decline of only 1.4 million in March and a net gain of 251,000 in February. More recently, the job market rebounded in May with the unemployment rate slipping to 13.3% and nonfarm payrolls showing an increase of 2.5 million jobs. As a result of the supply and (related) demand shock, the Personal Consumption Expenditure inflation rate fell to 0.5% in April from 1.3% in March.
In the euro area, the ECB followed suit. During its 12 March meeting, the ECB left unchanged its policy rates but announced an asset purchase program worth EUR120 billion for the remainder of the year. The ECB enacted these measures on 18 March, establishing a EUR750 billion Pandemic Emergency Purchase Programme that removed prior restrictions limiting the ECB’s asset purchases to at most one-third of the outstanding sovereign bonds of a given market. Judging these measures to be sufficient, existing monetary policy measures were left unchanged at the ECB’s 30 April meeting. However, worsening economic conditions led the ECB to increase the volume of purchases under the program to EUR1,350 billion on 4 June. The euro area economy was hit hard by COVID-19, with GDP for Q1 2020 falling 3.1% y-o-y after gaining 1.0% in the previous quarter. Inflation also fell to an estimated 0.1% in May from 0.3% in April. In addition, the June economic forecast showed that the euro area’s GDP is expected to decline 8.7% y-o-y in 2020 from a previous forecast of 0.8% growth in March.
In Japan, the BOJ also enacted easing measures in the form of increased asset purchases. On 16 March, the BOJ left both the monetary policy rate and government bond purchases unchanged but announced an increase of JPY2.0 trillion in asset purchases of commercial paper and corporate bonds and of JPY6.0 trillion and JPY90 billion in purchases of exchange-traded funds and Japanese real estate investment trusts, respectively. On 27 April, acknowledging the worsening economic impact of COVID-19, the BOJ introduced more aggressive measures at its monetary policy meeting. While the interest rate target remained unchanged at 0%, purchases of commercial paper and corporate bonds were more than doubled to JPY20 trillion, and the upper limit on the purchase of 10-year government bonds was lifted. On 22 May, the BOJ announced that it would continue purchasing commercial paper and corporate bonds until March 2021, which is later than the previously announced deadline of September 2020. The GDP growth forecast for fiscal year 2020 was revised downward to between –5.0% and –3.0% from growth of between 0.8% and 1.1%. Japan’s GDP in Q1 2020 contracted by 2.2% y-o-y after falling 7.2% y-o-y in the previous quarter.
Other than monetary measures, advanced economies also introduced fiscal stimulus programs to help mitigate the impact of COVID-19. In the US, the Coronavirus Aid, Relief, and Economic Security Act was signed on 27 March, introducing a USD2.0 trillion package that includes direct payments to households. On 27 April, another USD484 billion package aimed at small businesses and hospitals was signed. In the euro area, the European Commission unveiled a proposed EUR750 billion stimulus package on 30 May. In Japan, the government announced a number of support measures on 6 April totaling JPY108 trillion. The monetary and fiscal policies introduced in response to the COVID-19 pandemic largely shaped bond yield patterns in advanced economies.
Between 28 February and 29 May, the 10-year government bond yield declined in the UK and the US, while it rose in Germany and Japan. In March, all advanced economies witnessed a spike in the 10-year government bond yield, driven by deficit concerns in response to the fiscal stimulus measures announced in the US. Markets gradually returned to normal shortly thereafter (Figure A). In the case of Germany and Japan, yields ended the review period slightly higher as both the ECB and the BOJ focused largely on asset purchase programs to guide interest rates. The outbreak of COVID-19 has caused a steep decline in global economic development. The Asian Development Bank (ADB) estimates the global economic impact of COVID-19, excluding the impact of policy measures, at between USD5.8 trillion and USD8.8 trillion (6.4%–9.7% of global GDP).2 The potential economic impact on Asia and the Pacific is estimated at USD1.7 trillion (6.2% of regional GDP) under a 3-month containment scenario and USD2.5 trillion (9.3% of regional GDP) under a 6-month containment scenario. As discussed, global governments and central banks have launched massive stimulus packages to mitigate the negative impact of COVID-19 on the economy.
The huge economic losses caused by COVID-19 and the continued uncertainty surrounding its containment significantly restricted investment appetite in financial markets. Most equity markets in emerging East Asia posted losses during the review period on heightened risk aversion, with the largest declines recorded in Singapore (–16.6%), the Philippines (–14.0%), and Indonesia (–12.8%) (Figure B). Equity markets in the Republic of Korea and Thailand posted slight gains on the back of improved investor sentiment due to effective containment of COVID-19 in the case of the Republic of Korea and a partial lifting of lockdown measures in Thailand on 17 May. March saw the largest outflow across the region’s equity markets, with all markets posting outflows (Figure C). During the review period, nearly all emerging East Asian currencies weakened vis-à-vis the US dollar on the back of subdued investment sentiment (Figure D).
The Malaysian ringgit saw the largest decline at 3.0% amid capital outflows and a slump in oil prices. The Philippine peso and Hong Kong dollar bucked the regional trend, appreciating 0.7% and 0.5%, respectively, versus the US dollar during the review period. The strengthening of the peso was supported by a stronger balance-ofpayments surplus and increased gross international reserves. In 2019, the balance-of-payments surplus in the Philippines reached USD7.8 billion, or the equivalent of 2.2% of GDP, the highest level since 2012. At the end of April 2020, gross international reserves climbed to USD90.9 billion, or the equivalent of 8 months of goods and services. Recently, regional currencies have recovered somewhat as investor sentiment slightly improves. This has created challenges for markets such as Thailand, as it seeks a weaker Thai baht to improve exports and attract tourists. Heightened uncertainty and subdued investment appetite not only led to a climb in the regions’ risk premiums but also caused concerns regarding debt refinancing and a rise in financing costs. Credit default swap spreads in emerging East Asia rocketed upward in March and were largely volatile at their higher levels in April before falling slightly in May (Figure E). The CBOE Volatility Index and the EMBIG spread also showed similar patterns, with large spikes in March followed by volatility at elevated levels (Figures F and G). Box 1 describes the rise of risk premiums in financial markets in more detail.
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