By Natalia Gurushina
Chief Economist, Emerging Markets Fixed Income
The markets are in a somber mood today, as investors assess growth/inflation policy tradeoffs and China’s growth/COVID challenges.
Global Growth/Inflation Tradeoffs
It’s Day 4 of our research trip to Central Europe, and the deteriorating global sentiment – against the backdrop of upside inflation surprises, growth headwinds and concerns about available policy space – permeates all discussions. Two issues that pop out most frequently are: (1) share of inflation that can be attributed to global factors (=whether central banks can address price pressures without slowing the economy too much); and (2) coordination between monetary and fiscal policies (=growth/inflation trade off). Both issues are relevant not only for EMEA (or wider emerging markets (EM)), but also for developed markets (DM). An example of the latter are growth headwinds in the U.S. created by a combination of fiscal and monetary tightening. By contrast, a more accommodative fiscal stance in Europe might help to mitigate at least some recession risks.
Global/Domestic Inflation Drivers
Central banks emphasized during our meetings that rate hikes can only target a small portion of upside inflation pressures stemming from domestic demand (20% or so). And at times, some of them sounded as if their job (rate hikes) was almost done. However, underestimating the second-round effects from global price shocks can result in falling behind the curve, putting more pressure on local bonds and currencies. We will be having two more rate-setting meetings in other parts of EM this week – Mexico (+50bps expected) and Peru (+50bps expected), and it will be interesting to see how these challenges are addressed by their respective central banks.
China FX Weakness Tolerance Limit
China might be far from Europe geographically, but it is always an important part of regional discussions due to trade connections and the renminbi’s role as a general anchor for many EM currencies. The renminbi continued to creep closer to not-so-magnificent 7 against the U.S. dollar, with another big move today (down by 100bps as of 8:25am ET, according to Bloomberg LP). We maintain that this is the right direction, given the shrinking interest rate differentials with the U.S., capital outflows and near-term growth concerns. However, the speed of the adjustment might be too fast for the central bank, so we would not be surprised to hear more from it in the not-so-distant future. Stay tuned!
Chart at a Glance: Chinese Renminbi’s Depreciation – Too Fast for Comfort?
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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