Global Rates – Approaching the Endgame?
21 March 2023
Read Time 2 MIN
Fed Policy Rate Outlook
The market is in a risk-on mood going into tomorrow's U.S. Federal Reserve (Fed) meeting. The Fed’s (and the Swiss National Bank’s) response to the banking debacle was deemed effective enough to leave the “OMG/SOS” narrative behind (see chart below) and even resurrect one remaining 25bps rate hike as a nod to price stability issues. The emerging new story also features stronger developed markets (DM) growth headwinds stemming from tighter financial and lending conditions, which might necessitate rate cuts before year-end. We’ll find out tomorrow whether the market is reading the situation correctly, but a small hike and/or weaker growth prospects might not alleviate all inflation concerns, and this clouds the outlook for duration trades both in emerging markets (EM) and developed markets.
EM Rate Cuts
EM reaction to banking turbulence in DM has been orderly so far, with stresses concentrated mainly in sovereign frontier bonds, which are the most sensitive to higher interest rate volatility. The implied policy reaction by EM central banks also looks quite detached from the Fed. Policy rates in many had already peaked – a consequence of early and aggressive post-pandemic rate hikes and generally more orthodox policy frameworks, which allow currencies to act as effective shock absorbers, while easing pressure on international reserves. If anything, the latest DM shock led to lower – not higher! – expected peak rates in EM Asia, as well as South Africa, Mexico, and Colombia.
China Rebound
The mini-crisis also provided more evidence that some EMs are now more correlated with China than the Fed – and the latest activity indicators give reasons to be optimistic about the pace of recovery. China’s economic surprise index jumped to the highest level since 2006, outpacing both EM peers and DM counterparts. Suggestions from some Chinese officials to step up support for consumers – including a direct stimulus package – show understanding that consumption might continue to lag behind if the housing sector recovery is too slow/timid to boost consumer confidence. Stay tuned!
Chart at a Glance: Fed Expectations – Rapidly Changing Narratives
Source: Bloomberg LP.
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