Growth, Prices, Rates – Slower Pace?

Fed Policy Rate Path

Recession concerns and nascent disinflation explain why the market is comfortable pricing in smaller rate hikes and even some rate cuts going forward. The Fed Funds Futures show a 50bps U.S. Federal Reserve (Fed) hike in December, and a total of 38bps of rate cuts in the second half of 2023. It would be interesting to see whether Fed Chairman Powell’s presentation on Wednesday will change these expectations. As regards emerging markets (EM), Chile leads the “easing” pack with around 545bps of rate cuts priced in for the next year. The outlook for other EMs is much less aggressive, but even disinflation laggards like Mexico are expected to make room for rate cuts (to the tune of 90bps) in H2-2023.

China Reopening

The latest China headlines – the anti-lockdown protests and a spike in the number of new COVID cases – led to confusion about the pace of re-opening, weighing on near-term growth expectations. The consensus thinks that China’s domestic activity gauges will show further deterioration in November. This would explain Friday’s pre-emptive cut in the reserve requirements for banks (albeit many observers are skeptical that the move would make a big difference for funding costs, given that the cut was very small – only 25bps). One possible outcome is that the protests might lead to more policy stimulus to compensate for the re-opening setbacks. Market participants reacted positively to reports of further support for real estate developers, including low interest loans to buy developers’ onshore bonds.

Brazil Fiscal Debates

Brazil is among very few countries where the market continues to price in additional rate hikes – after pricing in a decent number of rate cuts going into the presidential elections. The local swap curve added at least one more hike for the next six months (a total of 101bps). This might look excessive/too hawkish, but these expectations reflect concerns about the new administration’s spending plans for the next four years, which can reverse the post-pandemic decline in Brazil’s debt-to-GDP ratio (see chart below). Fiscal/policy continuity concerns had a major impact on Brazil’s local debt performance in November (the only negative total return among all GBI-EM constituents). The damage can be undone, but it would require more certainty and less controversy about the fiscal outlook. Stay tuned!

Chart at a Glance: Brazil Debt/GDP Ratio – Lower But Still Very High

Source: Bloomberg LP.

BZDPGDT% Index – Brazil General Government Gross Debt Percentage. Represents Brazil’s debt-to-GDP ratio.