Run-Up to U.S. Recession Is Good Time for Emerging Markets


Thursday, August 02, 2018 /09:50AM / FDC

Global Perspective: Culled from Bloomberg

The end of easy money, a trade war and myriad geopolitical dangers weren’t enough, a U.S. yield curve poised to invert is adding to the risks for investors. But there’s one asset class that’s less of a worry: emerging markets.

Every time the yield curve has flipped in the past three decades, sending shorter-term interest rates above longer-term ones, the U.S. economy has entered a recession within 12 to 24 months. While that correlation makes the inverted curve a risk-off signal, it’s been a different story with emerging-market assets.


History suggests that the inversion has no influence on emerging markets. At best, it might be a bullish signal. Developing-nation stocks outperformed U.S. equities when the spread between 10-year yields and 2-year yields was negative in the run-up to a recession in 1990 and 2007. They trailed U.S. stocks in 2000, before the economy started contracting the following year, leaving the score at 2-1 in favor of emerging markets.

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With bonds and currencies the picture is more clear-cut. Both climbed against U.S. assets in the last two recessions (data before the 1990 recession isn’t available). Investors also cut the risk premium for owning emerging-market sovereign dollar bonds rather than U.S. Treasuries on both occasions.

Developing-nation assets react to many external and idiosyncratic factors, and the yield curve isn’t able to influence their moves com-pared with those factors, according to William Jackson, an economist at Capital Economics Ltd. in London. But once a U.S. recession gets entrenched, it might affect risk appetite, pushing emerging mar-kets toward underperformance, he said.

Risk-On Regardless

On two of past three times yield curve inverted, EM stocks outperformed U.S.

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The spread between 10-year and 2-year yields is at 27 basis points, the lowest since August 2007. Similar gap be-tween 7-year and 2-year rates is at 24 bps, the narrowest since at least 2009. The 5-year rate is just 17 bps away from the 2-year one. They all continue to fall as growing concern about a recession is pushing investors to buy longer-dated Treasuries, while Federal Reserve rate increases are boosting the yield on shorter-term bonds.

July marks the 109th month of continuous economic expansion in the U.S. after it emerged from the last recession in June 2009, according to the National Bureau of Economic Research. That’s the second-longest phase of growth since 1854, beaten only by a 120-month stretch in the 1990s. The law of averages dictates that it’s a late-stage economy and a recession may be closer than the markets are pricing in.

Case Study of Vietnam

Vietnam has a population of about 90million representing almost half of Nigeria’s population. Similarly, Vietnam’s GDP of $123.6bn is paltry when compared to Nigeria’s $405.1bn. As a member of the Next Eleven Economies (countries with high potential to become the world’s largest economies in the 21st century along with the BRICS) which also includes Nigeria, Vietnam recognized the need for power improvements to sup-port its growth over the years. As a result, the country embarked on power reforms which started in 2005 when a new electricity law came into effect.

Through the establishment of the new electricity laws, Vietnam aimed to:

1.       Expand and improve the power system (resource development) through the development of com-petition

2.      Enhance the transmission lines

3.      Reduce transmission and distribution losses


4.      The Vietnamese government created competition in the power sector which drove the expansion and improvement by:

5.      Investment by the state-owned Vietnamese Electricity


6.      Generation and distribution companies became different units under a holding company (similar to the Power Holding Company of Nigeria)


7.      Build-Operate-Transfer (BOT) by granting concessions for construction and development

8.     Independent Power Projects (IPP) through the participation of private capital


Vietnam’s installed generation capacity was able to grow from 11,578MW in 2005 to 24,500MW in 2016 with transmission and distribution losses reducing by an annual average of 0.6% in the same period. However, the generation capacity in Nigeria, which can be grouped with these countries, has basically remained flat throughout this same period.

Lessons for Nigeria

There is a lesson for Nigeria to learn from Vietnam’s power sector progress. Just like Vietnam, Nigeria’s power sector reforms involved changing the structure of the sector to separate generation, distribution and transmission units. Vietnam was able to effectively create competition in the sector while Nigeria has not succeeded in achieving this so far. The defining and key factors which made the difference in the two countries over the past years are reduced corruption in the sector better management.

The government of Vietnam was able to show better management of the power sector which attracted the needed investments into the sector. Even though Viet-nam has a notorious reputation for endemic graft, the government was able to stem this corruption to allow progress in the power sector.

Corruption and poor management have been high-lighted as the cause of the poor state of Nigeria’s power over the years. The privatization of the generation and distribution companies in 2013 has been stalled due to these same factors. Effectively removing these factors from the sector will hasten the reforms and attract the needed investments that would create competition, diversify the generation mix from thermal and hydro generation and aid in the development of the human capital needed to support the reforms.

Notable developments in the power sector

Multilateral organizations raise $1.57bn to expand Nigeria’s power grid Multilateral organizations such as the World Bank and African Development Bank (AfDB) have raised $1.57bn for the Transmission Company of Nigeria (TCN) to expand Nigeria’s electricity grid to 20,000MW by 2023. The funds were raised to implement the TCN’s Trans-mission Rehabilitation and Expansion Programme (TREP). An increase in power output would support growth in the manufacturing sector and boost aggregate output.


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