Emerging Market Sovereign Spreads, Global Financial Conditions and U.S. Macroeconomic News

This paper investigates the impact of global financial conditions, US macroeconomic news and domestic macroeconomic fundamentals on the evolution of EMBI spreads for a panel of 18 emerging market (EM) countries using daily data. To this end, we employ not only the conventional panel data estimation procedures but also the recently developed common correlated effects panel mean group method which incorporates heterogeneity by allowing country-specific coefficients whilst accounting for the effects of common global shocks such as contagion. The results strongly suggest that the long-run evolution of EMBI spreads depends on external factors such as changes in global liquidity conditions, risk appetite and crises contagion. Domestic macroeconomic fundamentals proxied by sovereign country ratings are also found to be important in explaining the spreads. The results from panel equilibrium correction models suggest that EMBI spreads respond substantially also to US macroeconomic news and changes in the Federal Reserve’s target interest rates. The magnitude and the sign of the effect of US macroeconomic news, however, crucially depend on the state of the US economy, such as the presence of an inflation dominance.