By Natalia Gurushina
Chief Economist, Emerging Markets Fixed Income Strategy
Van Eck Associates Corporation

Summary

Russian assets are being expelled from global indices as the war continues. Global concerns about higher energy prices/inflation persist, but central banks in EMEA/LATAM and EM Asia are responding differently.

Russian Sanctions

The economic and market consequences of Russia’s military campaign in Ukraine continue to pile up. More and more international companies (energy, automakers, retail, etc.) are cutting ties with Russia. We see the emergence of the two-tier exchange rate system, with a sizable gap between onshore and offshore rates. The economy is now expected to shrink by 10-20% in real terms in 2022. Yesterday, Russian equities were expelled from the MSCI and FTSE Russell1Indices and Fitch2cut Russia’s sovereign rating by six notches to B (on negative watch), citing rapidly tightening sanctions and a severe shock to credit fundamentals. It is just a matter of time before Russia will be excluded from global bond indices – the chart below shows that Russia’s weight in J.P. Morgan’s sovereign, local currency, and corporate bond indices are approaching zero.

Emerging Markets Inflation Risks

An interesting – albeit most likely theoretical – question is what happens to Russia’s inflation going forward, as a major recession and a significantly weaker currency (the ruble was down by nearly 40% since mid-February) will be pulling in the opposite direction. We suspect that Russia has a good chance to join Argentina and Turkey in the “50+” inflation club in the coming months. Turkey became a member this morning, with headline inflation surging more than expected in February (54.44% year-on-year), and it is now officially higher than Argentina’s inflation (in part because of the Turkish lira’s massive devaluation at the end of 2021). And there are no signals from the Turkish central bank that it changed its mind on rate cuts.

Emerging Markets Monetary Policy Response

Globally, a sharp increase in energy prices remains a key concern for policymakers – especially in Europe (including EMEA). Hungary decided to take no chances after an upside inflation surprise last month, and delivered a larger than expected 75bps increase in the 1-week deposit rate this morning. On the other hand, Malaysia stayed on hold this morning, despite mentioning inflation risks. Our general observation is that emerging markets (EM) rate expectations for the next six months did not move too much since the start of the Russia/Ukraine war, and changes that did take place were not uniform. Is this status quo bound to change going forward? Stay tuned!

Chart at a Glance: Russia’s Rapidly Shrinking Index Weights

Chart at a Glance: Russia’s Rapidly Shrinking Index Weights

Source: Bloomberg LP

1FTSE Russell – a British provider of stock market indices and associated data services, wholly owned by the London Stock Exchange (LSE).

2Fitch Ratings Inc. – is an American credit rating agency and is one of the “Big Three credit rating agencies”, the other two being Moody’s and Standard & Poor’s. It is one of the three nationally recognized statistical rating organizations designated by the U.S. Securities and Exchange Commission in 1975.

Originally published by VanEck on March 3, 2022.

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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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