By Natalia Gurushina
Chief Economist, Emerging Markets Fixed Income
EMs keep an eye on changes in the U.S. Federal Reserve’s guidance, but domestic fundamentals – including the pace of disinflation and growth outlook – are just as important.
Fed Rate Cuts
The focus of the day is the U.S. Federal Reserve’s (Fed’s) rate-setting meeting. The U.S. data-flow – including below-consensus ADP employment change and the ISM survey – are supportive of a smaller +25bps move, but the main “attraction” will be the Fed’s guidance. The market continues to price in rate cuts in 2023 (around 44bps), despite the fact that the Fed’s message has been more hawkish. The market expectation of policy easing in emerging markets (EM) and developed markets (DM) set a potentially positive stage for lower interest rates, driving EM performance at the end of 2022, and so far this year. And this is the reason why the EM folks will be glued to their Bloomberg screens this afternoon.
Some fundamental developments in EM argue in favor of ending the tightening cycles. Peak inflation is already behind in most countries – today’s downside surprises in Indonesia and Peru are good examples. A high base effect will also help to drive inflation down in the coming months – as will lower energy prices. The latter will have a particularly strong impact in Central Europe, where headline inflation can decline to single digits in Q4. Lower inflation is a boon for EM real yields, which already look attractive compared to their DM peers (see chart below).
China and EM Growth Tailwinds
There are risks though – and this is why many EM central banks are not in a hurry to open the door for rate cuts. Inflation is still far from the official targets in most places. Fiscal stimulus might still be positive in several EMs (due to a more populist policy agenda like in Brazil or an election cycle like in Poland). China might rebound at a faster pace – a potential upside risk for commodity prices, but also a major tailwind for EM growth, especially in countries with strong trade/tourism connections with China. Today’s stronger than expected activity gauges (Purchasing Managers Indices) in Thailand, Indonesia and the Philippines gave some food for thought in this regard. In Europe, the manufacturing PMIs in Poland and the Czech Republic continued to bounce from low levels. If the growth outlook continues to improve, EM central banks might feel comfortable staying on the sidelines for longer. Stay tuned!
Chart at a Glance: EM Real Local Rates – Nice Lineup!
Source: VanEck Research; Bloomberg LP.
Originally published by VanEck on 1 February 2023.
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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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