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Economic Policies vs. Geopolitical Risks

September 21, 2022

Read Time 2 MIN

Rising geopolitical risks sour the market sentiment going into the U.S. Federal Reserve meeting. Do EM’s policy rates provide sufficient cushions against the Fed’s rate hikes?

Russia–Ukraine War

The escalation of the war in Ukraine – President Vladimir Putin’s mobilization announcement and a threat to use all means necessary to protect Russia’s territorial integrity (whatever that means) – is weighing on sentiment this morning, with Central European currencies hit the hardest. This happens as the market is also preparing for the U.S. Federal Reserve’s (Fed’s) policy decision in the afternoon. The expectation is that the Fed will remain hawkish – a hike of at least 75bps and the terminal rate of 4.5% – but Chairman Jerome Powell’s press conference will be just as important.

EM Tightening Cycles

One question that’s been raised frequently is whether the hawkish Fed would put more tightening pressure on emerging markets (EM) central banks. We’ll have an answer this afternoon – the central bank of Brazil is scheduled to meet after the Fed, and the consensus believes it will remain on hold, ending the current hiking cycle. But is Brazil’s example representative? Brazil started to hike early and very aggressively, and currently Brazil’s real policy rate adjusted by expected inflation is the highest in EM. Further, Brazil’s policy rate differential with the Fed would still be in double–digits even after today’s expected central bank outcomes (i.e., Fed hiking by 75bps and Brazil staying on hold). The chart below shows that LATAM is generally in a pretty good spot as regards the policy cushion relative to the Fed. EMEA’s policy cushion also looks quite decent. However, the policy rate differential between EM Asia and the Fed will narrow to just over 100bps.

EM Rate Differentials with The Fed

Does it mean that some central banks in EM Asia would have to accelerate the pace of tightening? Especially latecomers like Indonesia? The Indonesian central bank is meeting tomorrow, and the median expectation is still for a moderate 25bps rate hike. Some brave souls, however, think that the central bank would have to frontload more hikes (+50bps). An additional consideration here is the government’s recent decision to raise some fuel prices by a larger than expected amount. This is a fiscally responsible move, aimed at reducing budget subsidies, but it will push headline inflation higher in the coming months. Stay tuned!

Chart at a Glance: EM Policy Cushions Look Different

Chart at a Glance: EM Policy Cushions Look Different

Source: VanEck Research; 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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