Chart of the day: When emerging markets trade through the G7
Thanks to Mohamed El-Erian for pointing this out in his latest Secular Outlook: the market risk spread on advanced economies now exceeds that on emerging economies.
Here’s Pimco’s explanation for what we’re seeing in this chart:
The difference in spreads shows the 5 year Markit CDX.EM.15 index minus the 5 year Markit iTraxx SovX G7 Index Spread. A positive number implies that Emerging Markets sovereign spreads are greater than Advanced Economy sovereign spreads. A negative number implies that Emerging Markets sovereign spreads are less than Advanced Economy sovereign spreads and therefore, the market implied credit risk for EM is lower when the spread is negative.
This is a very big deal, because the names in the EM.15 index are not exactly paragons of creditworthiness. Here’s the list: it starts with Argentina and Venezuela, and goes on from there, including countries like Panama, Russia, and Ukraine.
Meanwhile, the SovX G7 list is short and powerful: Germany, France, Japan, Italy, UK, and USA.
There are probably technical reasons why a group of AAA-rated sovereigns is trading wide of a group of much less creditworthy emerging markets in the CDS market. But the big message here is clear: the world is being turned upside-down. And most investors have yet to even start adjusting to these new realities.
Update: Turns out that the chart wasn’t measuring the G7 spread after all, but rather the Western Europe spread, which includes all the PIIGS.