EM Rate Hikes – No End in Sight

By Natalia Gurushina
Chief Economist, Emerging Markets Fixed Income Strategy, VanEck

Central Europe’s policy “double punch” – 75bps rate hike in Poland and 125bps in the Czech Republic – attracted a lot of attention. Aggressive rate hikes notwithstanding, the market continued to price in more tightening in the coming months

There is a popular saying (in one of the emerging markets (EM)) that appetite comes with eating – and this is exactly what is happening with the market expectations for policy normalization. Even though many central banks in EM are frontloading rate hikes right now, the market prices in more and more hikes for the next 12 months. The chart below shows that policy rates in most EMs are now expected to exceed the pre-COVID levels (sometimes significantly) in the coming months.

One obvious reason why this is happening is that past tightening had not been enough to stem inflation, which not only continues to surprise to the upside in many EMs, but is also 2-3 standard deviations higher than the multi-year averages. We saw this happening in Poland (3.1 standard deviations), South Korea (2.5 standard deviations), and Peru (mind-boggling 4.3 standard deviations) in the past week or so. Yesterday’s upside surprise in Russia was the latest in the series – both headline and core inflation are now above 8% year-on-year, well above the official target. The global “stagflation” narrative is quite popular right now, but the truth is that the pace of recovery in many EMs is stronger than expected, and this gives central banks extra room for policy tightening.

One region with a major hawkish policy U-turn is Central Europe. Poland was the last one to start policy normalization in October, and it has a lot of catchup to do despite two aggressive rate hikes totaling 115bps. Yesterday’s above-consensus rate increase in Poland was quickly followed by a 125bps move in the Czech Republic (vs. 75bps expected). The koruna reacted extremely well, gaining 52bps against the Euro (as of 10:40am ET, according to Bloomberg LP). Will Romania follow suit next week? Stay tuned!

Chart at a Glance: Market Prices In Aggressive Rate Hikes in Many EMs

Chart at a Glance: Market Prices In Aggressive Rate Hikes in Many EMs

Source: VanEck Research; Bloomberg LP

Originally published by VanEck on November 3, 2021.

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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.

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