Political Games vs. Macro – Who Wins?
30 March 2023
Read Time 2 MIN
China Geopolitical Goals
Headlines about the rising tensions between the U.S. and China continue to flood our Bloomberg screens – fanning debates about China’s long-term geopolitical aspirations and the renminbi’s possible (or is it likely?) ascendance as one of the world’s reserve currencies at the expense of the good old greenback. Many emerging markets (EM) are watching these developments with great interest – a possibility of playing China against the U.S. might look attractive going forward – but for now many seem content with the fact that their economies are arguably more correlated with China’s post-pandemic rebound than with the U.S. Federal Reserve’s rate cycle or developed markets (DM) banking mayhem. This explains why the next batch of China’s activity gauges will be closely watched this evening. The consensus is cautious – both the services and the manufacturing PMIs are expected to stay in expansion zone, but with no further improvement.
EM Inflation Risks
The pace of China’s rebound is an important driver for China’s inflation outlook (very benign right now) and China’s “exported” inflation – including a wider impact on global commodity prices, which can affect the disinflation momentum in EM. The latest communications from various EM central banks sounded hawkish (surprisingly so in some instances), with upside inflation risks being a top concern. And EM hawks continued to dominate the newsflow this morning. Brazil’s quarterly inflation report talked about the need to maintain restrictive policy stance for now, while the South African central bank surprised with a larger than expected +50bps rate hike, raising this year’s inflation forecast. The rate-setting meetings in Mexico and Colombia this afternoon now look even more interesting.
EM Market Performance
While this is happening, the market continues to price in EM rate cuts in the next six months. These expectations are on the optimistic side, but EMs’ “cautious for longer” policy bias can easily create more room for rate cuts in the fall and beyond. In the meantime, high real interest rates in EM can improve local bonds’ valuations and shelter EM currencies from market turmoil in DM. Stay tuned!
Chart at a Glance: Market Still Sees Rate Cuts in EM
Source: Bloomberg LP.
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