EM – Prepared For More Turmoil?
March 24, 2023
Read Time 2 MIN
Market Expectations for The Fed
Concerns about “dry wood” in developed markets (DM) banks refuse to go away, driving recession fears up and market expectations for the U.S. Federal Reserve (Fed) policy rate down. However, while short rates are dropping like a stone, very long rates are still range-bound – an indication that perceived inflation risks are yet to decline. The consensus outlook for emerging markets (EM) inflation is also cautious in the sense that inflation can realistically return to target already this year only in one region – EM Asia (we should also mention Brazil and South Africa here, but these are exceptions in their respective regions). Still, the timely policy response earlier in this cycle means that EM real policy rates adjusted for expected inflation are much higher than in DM, providing a safety cushion when things get tough. Another differentiator this time around is EMs’ stronger correlation with China, which is clearly on the rebound and set to grow much faster this year than any DM.
EM Rate Cut Prospects
High real policy rates notwithstanding, EM central banks are not in a rush to cut. The top domestic reasons include uncertainty about the pace of disinflation and concerns that inflation expectations could remain unanchored if central banks move prematurely. Brazil’s disinflation progress has been spectacular – today’s mid-month prints showed further moderation to 5.36% year-on-year – but waves of political and policy noise keep the central bank on its toes. The presentation of the new fiscal framework was delayed, and President Luiz Inácio Lula da Silva’s (Lula’s) renewed attacks on the central bank forced the market to re-adjust expectations for near-term rate cut prospects (as well as preventing the Brazilian real from participating in the post-Fed EM FX rally).
EM Bonds and Market Volatility
Of course, EM is not a monolith – EM Graduates might be in a better position to deal with market turbulence, and many EM currencies behaved as safer havens during the previous (banking mini-crisis) episode. However, frontier markets are definitely more exposed. Spreads on lower-rated sovereign bonds show strong correlation with global interest rates’ volatility (see chart below), and this particular factor was behind EM High Yield sovereign bonds’ month-to-date underperformance despite a big rally in the treasury portion of their total return. Stay tuned!
Chart at a Glance: EM High Yield Bonds – DM Rates Volatility Is A Major Risk Factor
Source: Bloomberg LP.
The J.P. Morgan EMBI Global Diversified HY Sovereign Spread Index is a subset of the J.P. Morgan Emerging Market Bond Index Global Diversified (EMBIGD), which is an unmanaged, market-capitalization weighted, total-return index tracking the traded market for U.S.-dollar-denominated Brady bonds, Eurobonds, traded loans, and local market debt instruments issued by sovereign and quasi-sovereign entities.
The ICE BofA MOVE Index tracks fixed income market volatility.
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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.