Bumpy Ride for EMs

Global Volatility

Global interest rates’ volatility (MOVE Index)¹ remains extremely high by historical standards, and global FX volatility (JPMVXYGL Index)² is the highest since the onset of the COVID pandemic. Emerging markets (EM) currencies with questionable fundamentals (a lack of fiscal adjustment, widening external deficits, political noise) find themselves under more pressure in this environment. Being close to a major geopolitical hotspot (Russia/Ukraine war) – in addition to having yet another spat with the key trade partner (European Union) – helps to explain why the Hungarian forint is the third worst-performing global currency (“extended majors”) so far this year after the Turkish lira and the Argentine peso. And the forint is struggling again this morning, weakening by 216bps against the U.S. Dollar (as of 10:20 am ET, according to Bloomberg LP). Hungary is also at the bottom of the EM local debt year-to-date total return ranking (see chart below). Hungary’s aggressive rate hikes – with the nominal policy rate now close to Brazil – do not make a lot of difference when other policies are weak.

LATAM Politics

The country’s local debt performance is unique in Brazil – this is the only constituent of the J.P. Morgan’s EM local debt index (GBI-EM), which has positive interest rate, price, and FX year-to-date returns (check the chart below). The question is whether Brazil’s relative outperformance can hold after the weekend’s presidential elections. The recent polls suggest that the former president Luiz Inácio Lula da Silva – known for his populist bias – might win in the first round. We might see some knee-jerk market reaction if that indeed happens, but Lula has been leading in the polls for quite some time now, so his electoral victory should be more or less priced in. In his recent communications, Lula sounded more centrist and market-friendly. But as usual, we will need to see the cabinet line-up, the composition of the parliament, and policy announcements before the final assessment.

EM Tightening Cycle

The total return table below also explains why the market keeps an eye to today’s rate-setting meeting in Mexico and the Czech Republic. Czech local bonds did not perform too well this year, but the national bank kept the policy rate on hold this morning (there were some residual concerns about a rate cut) and the governor’s statement was not excessively dovish. Mexico’s local debt is among top 5 performers so far this year, with a high interest return and a non-negative FX return. The market expectations for Mexico’s central bank have been moving in lockstep with the U.S. Federal Reserve in the past couple of months, and the consensus expects to see a 75bps rate hike in the afternoon. The wording of the statement and guidance will also be key – as of this morning, the local swap curve was pricing in a fairly aggressive interest rate path for the next 6 months (around 200bps of additional hikes). Stay tuned!

Chart at a Glance: EM Local Debt “League Table”

Source: Bloomberg LP.

¹ MOVE Index – This is a yield curve weighted index of the normalized implied volatility on 1-month Treasury options. It is the weighted average of volatilities on the CT2, CT5, CT10, and CT30. (Weighted average of 1m2y, 1m5y, 1m10y and 1m30y Treasury implied vols with weights 0.2/0.2/0.4/0.2, respectively).)

² JPMVXYGL Index – J.P. Morgan’s Global FX Volatility Index keeps track of currency volatility. The global volatility index consists of 22 different currencies: Australian Dollar, Brazilian Real, Canadian Dollar, Swiss Franc, Chinese Yuan, Euro, British Pound, Hungarian Forint, Indian Rupee, Japanese Yen, South Korean Won, Mexican Peso, Norwegian Krona, New Zealand Dollar, Philippine Peso, Polish Zloty, Russian Rouble, Swedish Krona, Singapore Dollar, Turkish Lira, Taiwan Dollar and the South African Rand.