Emerging markets’ spreads and global financial conditions

In this article, we analyze how much of the reduction in emerging markets’ spreads can be ascribed to specific factors—linked to the improvement in a given country's fundamentals, rather than to common factors—linked to global liquidity conditions and agents’ risk aversion. By means of factor analysis, we find that a single common factor is able to explain a large part of the co-variation in emerging market economies’ (EMEs) spreads observed in the last 4 years; in turn, this common factor can be traced back mainly to financial market volatility. Due to the particularly benign global financial conditions of recent years, spreads seem to have declined to below the levels warranted by improved fundamentals. As a consequence, EMEs do remain vulnerable to sudden shifts in financial market conditions.