By Natalia Gurushina, Chief Economist, Emerging Markets, Fixed Income Strategy
Russia’s gutsy rate hike and fiscal frugality contrast sharply with Turkey’s larger than expected cut and Brazil’s fiscal uncertainty. The currencies’ recent diverging performance is a reflection of diverging policies.
Emerging markets (EM) FX performance this morning is a great illustration of our motto “EM is not a monolith”. It also shows that the market does differentiate between good and bad EM policies. The Russian ruble and the Mexican peso are leading the currency pack. Russia’s central bank delivered a gutsy 75bps rate hike this morning – that was only 1/3 priced in (25bps) – and signaled that there could be more tightening in the future if inflation pressures do not subside. Mexico’s rate-setting meeting is in early November, but the central bank’s recent reaction function suggests that it might go for another measured rate hike following today’s upside surprise in bi-weekly inflation (especially in core inflation).
The Turkish lira and the Brazilian real are firmly in the red this morning. The lira is still reeling from yesterday’s bigger than expected rate cut, hitting another historic low against the U.S. Dollar. The U.S. Financial Action Task Force (FATF) decision to add Turkey to its “gray list” of high-risk and non-cooperative jurisdictions did not help either. A major risk is that the rate cut and the resulting currency weakness will add to inflation pressures (the central bank’s credibility is low, so FX-inflation pass-through is high), creating a negative feedback loop. In addition, lower funding costs are likely to re-accelerate credit growth, bringing back overheating concerns.
Brazil’s descending into another policy/political mess is the main reason for the real’s underperformance. First, it looks like authorities will go ahead with a larger social program, part of which might be financed outside the spending cap. Second, there is a proposal to change how the spending cap is calculated. Finally, several top Treasury officials – some of whom just met with investors during the IMF Annual Meetings – had had enough and submitted their resignations yesterday. The government’s “market friendly” face – Economy Minister Guedes – said that he will stay. But his reason – not to worsen the crisis – is hardly reassuring. Brazil’s bond vigilantes are back, with the 10-year government bond yield reaching 12% this week (7% back in January). And the markets now expect the central bank to be a “heavy-lifter”, and accelerate the pace of tightening to 150bps next week and in December. Governor Campos Neto indicated a few weeks ago that he would do whatever it takes to bring inflation back under control – will he deliver? Stay tuned!
Chart at a Glance: Today’s EMFX Performance Is A Reflection of Policy Divergence
Source: Bloomberg LP
Originally published by VanEck on October 22, 2021.
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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