Natalia Gurushina, Chief Economist, Emerging Markets Fixed Income Strategy
June 22, 2020
China’s latest activity gauge weakened in June. South Africa is expected to have the largest fiscal deficit among key EMs in 2020 and 2021.
China’s latest activity gauge suggests that the recovery remains uneven and it is too early to contemplate the stimulus withdrawal. The Emerging Industries Purchasing Managers Index (PMI) – closely watched these days due to its correlation with the official PMI - stayed in the expansion zone in June, but dropped by 4.5 points to 51.4. Beijing’s second wave and South Korea’s preliminary foreign trade numbers point to multiple headwinds going forward, including depressed regional and global trade. So, even though China’s central bank chose to keep both 1-year and 5-year Loan Prime Rates (LPR) unchanged over the weekend, it has enough tools in its toolkit to step up easing if headwinds become stronger.
We’ve got some scary fiscal headlines in South Africa over the weekend, suggesting that the gross government debt might top 100% of GDP by 2025. The currency, perhaps surprisingly, is doing OK this morning. We suspect this is because a lot of negativity is already priced in. There were also some encouraging remarks from Minister of Finance Tito Mboweni, who told the parliament that the county needs to live within the means. Importantly, there is a still lot of confidence that South Africa’s key institution – the central bank – has enough credibility. Still, South Africa is expected to have the largest fiscal gap among key emerging markets both in 2020 (>14% of GDP) and 2021 (>10% of GDP) – which is bound to generate bouts of market volatility.
EM central banks are cutting benchmark rates to historic lows (Poland, Brazil, Russia just days ago), but local curves are increasingly pricing in policy reversals and rate hikes in the coming months (see chart below). One telling example is Brazil, where the real policy rate is now below zero and the central bank might go for another rate cut this summer. The market, however, looks very uncomfortable with the idea of the zero neutral rate in the economy like Brazil, thinking that this ultra-dovish stance will be over soon and expecting 150bps of policy tightening in the next 12 months.
Chart at a Glance: Markets Increasingly Price In rate Hikes in Major EM
Source: Bloomberg LP
IMPORTANT DEFINITIONS & DISCLOSURES
PMI – Purchasing Managers’ Index: economic indicators derived from monthly surveys of private sector companies; 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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