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U.S. Fed - No Pivot For You!

August 03, 2022

Read Time 2 MIN

The U.S. Fed continues to stress that its current policy priority is inflation. How does this affect EMs, some of which are facing an H2 growth “cliff”, while energy prices might not ease much near-term?

Global Rates Selloff

Yesterday’s selloff in U.S. rates – which continued this morning - was a reminder that the market should pay more attention to the Federal Reserve’s (the Fed) message rather than its own narratives/thought constructs. A barrage of hawkish statements from the Fed – which clearly prioritized fighting high inflation - added several basis points to the expectations for the Fed’s rate hike in September (now at 62bps), but, curiously, the market refuses to see more hikes beyond December (see chart below). Growth “fatigue” and a greater risk of recession is a major reason. The 2023 consensus forecast for the U.S. has been cut to 1.3%, and today’s extremely weak retail sales in the Eurozone signal that the investment community might be underestimating growth headwinds in other independent global growth drivers. Emerging markets (EM) are also affected by these concerns. Manufacturing activity surveys for July pointed to a possibility of an H2 growth “cliff” in more than one country, and a sharp slowdown in retail sales in Hungary and Romania signaled that high inflation started to affect consumer sentiment.

Global Energy Prices and Inflation

Going back to inflation pressures, cooling domestic demand can make central banks’ job easier a few months from now, but supply-side and non-core price pressures can keep inflation expectations unanchored and above the target. This especially applies to fuel and energy prices, which account for a much larger share of consumer price baskets in EM than in advanced economies. This explains why today’s OPEC+ (the Organization of the Petroleum Exporting Countries and allies) proposal for a small increase in September’s crude oil output was met with a whiff of disappointment. 

China U.S. Treasury Holdings And Geopolitics

Today’s final point on global rates – that we discussed yesterday with colleagues – relates to geopolitics. U.S. House Speaker Pelosi’s visit to Taiwan Region went smoothly, but an uptick in geopolitical noise in the run up to the trip raised some concerns about China’s potential retaliatory moves, including its future “appetite” for U.S. Treasuries (UST). Of course, we are not talking about the full stop scenario. However, China is a big UST holder – albeit the volume declined after peaking in 2013-2015. What will happen to yields if China buys even less USTs going forward? Stay tuned! 


Chart at a Glance: U.S. Policy Rate Expectations – Limited Space for Hikes


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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