Rate Cuts and Sanity Checks
April 19, 2023
Read Time 2 MIN
Rate Cuts Expectations
Last week in DC, the IMF repeatedly cautioned against premature rate cut communications, but the Hungarian central bank either did not listen carefully, or decided to check what happens anyway. The currency (the Hungarian forint) had a very adverse reaction to an early rate cut suggestion from the deputy governor, weakening the most against the U.S. Dollar compared to emerging markets (EM) peers (as of 10:00am ET, according to Bloomberg LP). We are not saying that the IMF is always right, and we realize that some factors (like the mother of all base effects) argue for faster disinflation in H2. Hungary’s case is also quite extreme – we do not see 20%+ headline and core inflation (vs. 3% inflation target) very often in EM these days. Still, the forint’s reaction was a teachable moment, which hopefully got noticed by various EM central banks. High real rates helped to shield many EMs from this year’s market turbulence – and it is not wise to throw this cushion away while there are plenty of bumps on the disinflation road.
EM Disinflation
In fact, it might be prudent for some EMs to raise their policy rates a bit more. This is what the market currently prices in for South Africa, where headline inflation surprised to the upside in March, re-accelerating to 7.1% year-on-year, and core inflation stayed close to a multi-year high of 5.2% year-on-year. The surprise was mostly due to higher food prices - mega-drought in Argentina, as well as a rising probability of El Nino this year can create headwinds for disinflation not just in South Africa but in wider EM in the coming months.
LATAM Fiscal Outlook
Sanity checks for EM rate cuts can also come from the fiscal side. The market continued to adjust its expectations for policy easing in Brazil in 6-12 months, as it received the final version of the government’s new fiscal framework. Many details of the plan were known before, but the document confirmed that the new framework is more convoluted and less enforceable. There is also a lot of uncertainty about generating additional revenue to meet the primary fiscal targets (which might not necessarily stabilize the debt/GDP ratio). So, even though Brazil’s real policy rate is the highest among major EMs (around 8.7%), the local swap curve priced out about 50bps of implied rate cuts on a 1-year horizon within the past week (see chart below). It is not the end of Brazil’s easing story, but fiscal certainly is key for a big breakthrough. Stay tuned!
Chart at a Glance: Brazil’s Policy Easing Room – Fiscal Certainty Is Key
Source: 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.