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Global Rates – The Adjustment Bureau

June 14, 2022

Read Time 2 MIN

It is still an open question whether EMs will be forced to follow the Fed’s more hawkish policy stance. The market thinks this might not necessarily be the case for some of them.

Global Rate Expectations Sharply Higher

Yesterday’s market tantrum was brutal. The daily increase in the 2-year U.S. Treasury yield was the 10th largest since 1983. The market expectations for this week’s U.S. Federal Reserve (Fed) decision jumped to +74bps (from 56bps on Friday), and Bloomberg’s Fed Funds Futures page continued to show a +75bps/+70bps rate hike combo for June/July this morning. The near-inversion of the U.S. Treasury curve (see chart below) – the world’s favorite recession indicator – is back on the front-burner, and today’s sad-looking small business optimism index (which comes on the heels of the shockingly weak University of Michigan survey) added to concerns about the U.S. – and global – growth outlook.  

No Additional Hikes Price in Brazil

The current tightening cycle in the U.S. is different for many emerging markets (EM), because they started to adjust their own policy rates (in response to rising inflation) well before the Fed. The Brazilian central bank was among the trailblazers – and it frontloaded rate hikes very aggressively (Brazil’s real policy rate adjusted by expected inflation is the highest in EM). And we are wondering whether this is the reason why the local swap curve is not in a hurry to price in a lot of additional tightening, despite the more hawkish Fed (the terminal rate in the U.S. is now seen above 4%). The market-implied rate expectations for Brazil stayed close to +55bps for tomorrow’s rate-setting meeting (a slower pace of tightening), followed by an even smaller (35-38bps) hike in August. 

EM Central Banks – Potential Surprises Ahead

We have several policy meetings scheduled in EM until the end of the month – but some will be watched more carefully than others, starting with the Czech National Bank, which is going through a dovish board reshuffle, and where the outgoing hawks might deliver an oversized “goodbye” rate hike. Mexico is another interesting case – inflation pressures suggest that it will be difficult to avoid stepping up the pace of hikes to 75bps, especially if the Fed does the same. Finally, in EM Asia, Indonesia is among very few countries with inflation still within the official target range – but the central bank had fired the first warning shot last month in the form of an additional hike in the reserve requirements for banks, and the buzz about a proper rate hike there is getting louder. Stay tuned! 

Chart at a Glance: 2Y-10Y U.S. Treasury Curve Near-Inversion Re-Ignites Recession Fears

Chart at a Glance: 2Y-10Y U.S. Treasury Curve Near-Inversion Re-Ignites Recession Fears

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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