Market Sees Few EM Rate Cuts – Why?
March 03, 2023
Read Time 2 MIN
Hawkish Fed
Headline inflation had peaked in most emerging markets (EM) by now, but the market expectations for EM rate cuts over the next 12 months look quite “stingy” in most regions (see chart below). Further, some analysts are now talking about the need for “insurance” rate hikes in some EMs. These include South Korea (the local swap curve prices in +40bps more), India (the market sees another 52bps in the current cycle) and South Africa (50bps more or so). Two major LATAM economies are also on the list – Mexico (+60bps more) and Colombia (+75bps more). An easy explanation is that EMs feel obliged to follow the U.S. Federal Reserve (Fed) – a more robust 2023 growth outlook and a series of upside inflation surprises pushed the U.S. peak rate forecast to 5.4-5.5% recently. Well, this might be the case in Mexico (a “nearshoring” argument), but we think local factors play a more important role elsewhere.
Brazil Fiscal Outlook
Brazil is EM’s poster kid for successful disinflation (from 12.13% year-on-year to 5.77% in nine months). However, the fiscal policy uncertainty and new administration’s attempts to “convince” the central bank to lower the policy rate (in order to prop up growth) put the market (and the central bank) on the defensive. As of this morning, the local swap curve priced in only 95bps of rate cuts during the rest of the year. It is important to keep an eye on the new fiscal framework – the draft is expected to be finalized over the weekend – and what it means for the spending cap. The consensus sees the budget deficit widening from 4.7% of GDP in 2022 to 7.8% of GDP this year. But if the new framework looks credible, the market should see more room for policy easing before the year-end.
EM Policy Easing
One (local) reason behind various EM central banks’ caution is that underlying price pressures are often more persistent than headline, and core disinflation can take more time (a reflection of tight labor markets, for example). Central banks are also mindful of subsidy withdrawals, which is a good sign for the fiscal outlook but could result in “bumpy” disinflation progress. We do not see major problems with EM central banks’ cautious stance – especially if the growth outlook continues to improve at the margin. This combo provides a supportive backdrop for carry trades – additional Fed rate hikes notwithstanding – and leaves room for rates compression if disinflation progresses as expected (or faster). Stay tuned!
Chart at a Glance: EM Rate Cuts – Not Much Priced In
Source: VanEck Research; Bloomberg LP.
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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.
The information presented does not involve the rendering of personalized investment, financial, legal, or tax advice. This is not an offer to buy or sell, or a solicitation of any offer to buy or sell any of the securities mentioned herein. Certain statements contained herein may constitute projections, forecasts and other forward looking statements, which do not reflect actual results. Certain information may be provided by third-party sources and, although believed to be reliable, it has not been independently verified and its accuracy or completeness cannot be guaranteed. Any opinions, projections, forecasts, and forward-looking statements presented herein are valid as the date of this communication and are subject to change. The information herein represents the opinion of the author(s), but not necessarily those of VanEck.
Investing in international markets carries risks such as currency fluctuation, regulatory risks, economic and political instability. Emerging markets involve heightened risks related to the same factors as well as increased volatility, lower trading volume, and less liquidity. Emerging markets can have greater custodial and operational risks, and less developed legal and accounting systems than developed markets.
All investing is subject to risk, including the possible loss of the money you invest. As with any investment strategy, there is no guarantee that investment objectives will be met and investors may lose money. Diversification does not ensure a profit or protect against a loss in a declining market. Past performance is no guarantee of future performance.
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.
The information presented does not involve the rendering of personalized investment, financial, legal, or tax advice. This is not an offer to buy or sell, or a solicitation of any offer to buy or sell any of the securities mentioned herein. Certain statements contained herein may constitute projections, forecasts and other forward looking statements, which do not reflect actual results. Certain information may be provided by third-party sources and, although believed to be reliable, it has not been independently verified and its accuracy or completeness cannot be guaranteed. Any opinions, projections, forecasts, and forward-looking statements presented herein are valid as the date of this communication and are subject to change. The information herein represents the opinion of the author(s), but not necessarily those of VanEck.
Investing in international markets carries risks such as currency fluctuation, regulatory risks, economic and political instability. Emerging markets involve heightened risks related to the same factors as well as increased volatility, lower trading volume, and less liquidity. Emerging markets can have greater custodial and operational risks, and less developed legal and accounting systems than developed markets.
All investing is subject to risk, including the possible loss of the money you invest. As with any investment strategy, there is no guarantee that investment objectives will be met and investors may lose money. Diversification does not ensure a profit or protect against a loss in a declining market. Past performance is no guarantee of future performance.