By Natalia Gurushina
Chief Economist, Emerging Markets Fixed Income
Various EM central banks keep their eyes firmly on inflation, expectations, and factors that influence them (including fiscal). DM central banks’ motivations are still being questioned by the market.
Fed Rate Cuts
One big takeaway from yesterday’s meeting of the U.S. Federal Reserve (Fed) is that the Fed and the market still do not see eye to eye (the chart below is hard to un-see). The market latched onto Chairman Powell’s comments about the impact of tighter credit conditions on the growth outlook and inflation and refused to abandon its fairly aggressive easing expectations. Emerging markets (EM) currencies were not particularly upset about this state of affairs, extending the post-Fed rally against the U.S. Dollar this morning. The majority of EM bonds and many EM equities also looked quite happy (judging by the green color on our Bloomberg screens). There might still be “dry wood” in DM banks (hence, a risk of market turbulence going forward), but commentators agree that EMs passed the latest test with flying colors. This might be a reflection of EMs’ early policy response to post-pandemic price pressures (=high real rates), but also stronger structural and institutional frameworks, as well China’s role as an independent growth driver.
EM Policy Rate Outlook
And talking about policies, price stability (including anchoring inflation expectations) remains a top priority for various EM central banks - which means some residual rate hikes before it would be safe to take a pause, even in those cases when inflation had peaked. The Philippine central bank raised its policy rate by 25bps this morning and signaled that it might go for another hike if inflation risks remain to the upside. Mexico’s latest bi-weekly inflation prints were beautiful – suggesting that the 6% (headline) and 7% (core) thresholds are within reach, but some inflation components are sticky – so a 25bps hike next week would be a prudent move. South Africa is likely to do the same, as inflation expectations climbed higher in Q1.
EM Policy Objectives
Another strong policy signal in EMs is that a rate pause does not necessarily means that rate cuts are around the corner. Sometimes this is due to uncertainty about inflation expectations (yesterday’s comment from Brazil’s central bank). Sometimes, it’s a plain fact that inflation is still far from the official target. And sometimes, central banks’ caution reflects concerns about fiscal consolidation, a lack of which might lead to higher price pressures down the road. The latter is a big issue in Brazil, where the central bank acknowledged some improvements in the fiscal outlook but reiterated that a credible new fiscal framework is an important prerequisite for this year’s rate cuts. Stay tuned!
Chart at a Glance: Fed and Market – Not Seeing Eye To Eye
Source: Bloomberg LP.
Originally published by VanEck on March 23, 2023.
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PMI – Purchasing Managers’ Index: economic indicators derived from monthly surveys of private sector companies. A reading above 50 indicates expansion, and a reading below 50 indicates contraction; ISM – Institute for Supply Management PMI: ISM releases an index based on more than 400 purchasing and supply managers surveys; both in the manufacturing and non-manufacturing industries; CPI – Consumer Price Index: an index of the variation in prices paid by typical consumers for retail goods and other items; PPI – Producer Price Index: a family of indexes that measures the average change in selling prices received by domestic producers of goods and services over time; PCE inflation – Personal Consumption Expenditures Price Index: one measure of U.S. inflation, tracking the change in prices of goods and services purchased by consumers throughout the economy; MSCI – Morgan Stanley Capital International: an American provider of equity, fixed income, hedge fund stock market indexes, and equity portfolio analysis tools; VIX – CBOE Volatility Index: an index created by the Chicago Board Options Exchange (CBOE), which shows the market's expectation of 30-day volatility. It is constructed using the implied volatilities on S&P 500 index options.; GBI-EM – JP Morgan’s Government Bond Index – Emerging Markets: comprehensive emerging market debt benchmarks that track local currency bonds issued by Emerging market governments; EMBI – JP Morgan’s Emerging Market Bond Index: JP Morgan's index of dollar-denominated sovereign bonds issued by a selection of emerging market countries; EMBIG - JP Morgan’s Emerging Market Bond Index Global: tracks total returns for traded external debt instruments in emerging markets.
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