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All Kinds of Pivots In EM

August 04, 2022

Read Time 2 MIN

Brazil earned its right to exit its aggressive tightening cycle. Can other EMs be as successful in monetary policy adjustment?

Ending EM Rate Hike Cycles

Consider the following scenario - the end of the tightening cycle in 2022 and potential rate cuts in 2023. Nope, we are not talking about the market expectations for the U.S. Federal Reserve. This is a very likely new monetary policy trajectory in Brazil, following what might have been the final 50bps rate hike yesterday (see chart below). Brazil was hiking aggressively starting from early 2021, but all good (monetary policy) things eventually come to an end. A dovish tweak in yesterday’s statement - evaluating rather than foreseeing the need for a residual policy rate adjustment - suggests that the central bank might take a pause already at the next meeting. The end-result of the central bank’s preemptive policy response and peaking inflation is that Brazil’s real yields adjusted by expected inflation are among the highest in emerging markets (EM) (up to 10 years) relative to economic fundamentals.

EMs Falling Behind The Curve

Brazil’s dovish pivot was completely justified - something that cannot be said about the Czech National Bank, which surprised the market by staying on hold today. Granted, the expected rate hike was small (only 25bps), a big share of inflation is driven by external factors, and there are legitimate concerns about an H2 growth “cliff”. Still, taking a pause when annual inflation is above 17% has all the appearance of a policy mistake.

EM Liftoffs And Wider Policy Agenda

Not all policy pivots in EM are dovish. Central banks in EM Asia are on a hawkish offensive - we keep an eye on India this week, and Thailand on Aug 10 (the market expects a 25bps liftoff, which is long overdue). Some EM rate hikes look dramatic on a surface, but the overall policy framework is so weak that rate hikes by themselves would not make a lot of difference. We are talking, of course, about Argentina, where the central bank recently hiked by 800bps, but yesterday’s stabilization plan looked less impressive. The proposals had a shiny “wrapper” - four pillars and such. But there were no changes in the currency regime and only cosmetic fiscal measures. If these issues are not fixed, the current crisis will deepen further. Stay tuned!

Chart at a Glance: Brazil’s Tightening Cycle - Ready To Exit

Chart at a Glance: Brazil’s Tightening Cycle - Ready To Exit

Source: Bloomberg LP

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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