By Natalia Gurushina
Chief Economist, Emerging Markets Fixed Income Strategy
Van Eck Associates Corporation
Summary
The mood in EM remained hawkish this morning. The question is whether EM-specific policies can offset the negative impact of higher “risk-free” rates on bond indices’ total returns as the Fed continues to hike.
U.S. HIKING CYCLE AND EM RETURNS
The U.S. Federal Reserve Chair Powell’s hawkish comments – which opened the door for 50bps rate hikes – are still digested by the market this morning, with the 10-year UST yield nearly 10bps higher at the time of the note (as of 10:00am ET, according to Bloomberg LP). Fed Funds Futures now imply a total of 192bps of additional tightening until the end of the year. From the emerging markets (EM) Fixed Income perspective, higher “risk-free” rates accounted for (so far) a larger portion of this year’s bond index losses (compared to spread return). The question is whether EM-specific policies/developments can offset these losses going forward – just like they did in the two previous U.S. hiking cycles.
CENTRAL EUROPE STAGFLATION RISKS
Today’s mood in EM was equally hawkish. Hungary raised its policy rate by 100bps more to 4.4%, following a series of upside inflation surprises, and the consensus now expects a 30bps increase in the 1-week deposit rate on Thursday. The key challenge for monetary authorities in all Central European countries is dealing with the stagflationary fallout from the Russia/Ukraine war, which weighs on the growth outlook but is likely to push inflation higher from the already very elevated levels. Regional central banks are now resorting to currency interventions to minimize the inflationary pass-through from weaker FX. The Czech National Bank announced that it might sell some of its international reserves to support the koruna.
BRAZIL AGGRESSIVE FRONTLOADING
The swap curve in Brazil now firmly prices in another 100bps rate hike in May and at least 50bps in June. This is actually more than suggested by the central bank’s minutes released this morning, but a more optimistic guidance (fewer hikes) is based on the expectation of moderating oil prices. Further, inflation expectations continue to grind higher, and this can necessitate more policy action. Brazil’s aggressive rate hike frontloading is the reason why its real policy rate adjusted by expected inflation is now the highest among major EMs. Brazil’s real policy rate based on trailing inflation is also positive – unlike most EMs. This is one of the reasons why the currency is finally enjoying its place in the spotlight, being the best-performing EM FX so far this year (see chart below). Another reason, of course, is that commodity exporters are expected to benefit from disruptions caused by the Russia/Ukraine war. Stay tuned!
Chart at a Glance: Impact of Higher Food Prices on Lower-Income Countries
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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