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Recent rate hikes across emerging markets (EM) reflect a broad tightening bias, while most developed markets (DM) continue to maintain low nominal rates and negative real rates. The market is currently anticipating further tightening across nearly all non-Asian economies as central banks react swiftly to inflation upside surprises, as well as higher than expected growth and improving labor markets. The benefit of maintaining substantial positive real yields is illustrated in the chart below. EMs went into the pandemic-driven recession with the policy flexibility to react, and they were able to cut rates aggressively to stimulate growth. As the recovery has taken hold, all of the easing that had been implemented has been erased. DMs did not have nearly as much room to ease rates, and have maintained other, extraordinary, expansionary policies, despite strong economic growth and signs of inflation.
Source: VanEck Research; Bloomberg LPPPP GDP Weights: weighted average rate by GDP adjusted for different price levels in each country.
EMs do not have the same ability to tolerate higher than normal inflation, and for the last two decades have kept a closer eye on financial stability concerns, given their dependence on external funding. Central bankers have remained vigilant amid high inflation readings, maintaining their credibility and reliance on conventional monetary policies to keep inflation expectations in check. As is the case globally, price pressures have largely been supply-driven. In addition, many EMs are experiencing strengthening demand, as the growth recovery has been stronger than anticipated. While higher inflation in EMs has certainly detracted from EMFX returns so far this year, higher growth and the swiftness of central bank action may provide support going forward. Further, the rate differential between EM local currency bonds and U.S. interest rates, which was nearly at the lowest level in a decade going into the pandemic, has increased significantly this year.1 In nominal terms, the yield differential has moved out to approximately 4.1 percentage points, from 3.6 at the beginning of the year, and 3.4 at the beginning of 2020. This increased buffer provided by market interest rates may also help provide support for currencies, in our opinion.
1Source: J.P. Morgan as of 30/9/2021, as measured by the yield difference between the J.P. Morgan GBI-EM Global Diversified Index and on-the-run 7-Year U.S. Treasury.
J.P. Morgan GBI-EM Global Diversified Index is comprised of bonds issued by emerging market governments and denominated in the local currency of the issuer.
ICE BofA Diversified High Yield US Emerging Markets Corporate Plus Index tracks the performance of US dollar denominated below investment grade emerging markets non-sovereign debt publicly issued in the major domestic and eurobond markets.
ICE BofA US High Yield Index tracks the performance of US dollar denominated below investment grade corporate debt publicly issued in the US domestic market.
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