A tame Fed provided a much-needed market respite, and EM with strong policy frameworks are set to benefit. As this happens, be mindful of EM policy “contagions” of another kind, which can be less forgiving.
A prospect of China’s tech contagion spooked the market big time earlier this week, but it looks like a combination of some local damage control, a tame U.S. Federal Reserve (Fed) and the fact that U.S. GDP finally exceeded the pre-pandemic level in real terms (see chart below) provided a much needed respite. This might be a good moment to talk about another kind of emerging markets (EM) contagion - policy “contagions” - and we start with the one that is outright good. “EM Policy Contagion of the First Kind” is the proliferation of orthodox monetary policies across EM. The most obvious manifestation, at this moment, is the frontloading of EM rate hikes in order to cap inflation risks (and not because of the Fed). The Czech National Bank might be the next in line after some board members called for more aggressive tightening. Even the Turkish Central Bank sounded cautious in its just-released quarterly inflation report. If you check today’s EM FX performance ranking, many currencies with “aggressive” central banks behind them are in the lead.
“EM Policy Contagion of the Second Kind” has some populist connotations and should be watched closely. We are talking about withdrawals from private pension funds to ease near-term economic hardship. LATAM currently dominates the headlines, but now it looks like South Africa really liked the idea and might soon join the club. The immediate market impact of these measures is more ambiguous - especially in countries where pension funds’ assets are huge as a percentage of GDP (like in Chile or South Africa). But the longer-term impact from multiple withdrawals on the fiscal trajectory and local debt and equity markets could be negative.
“EM Policy Contagion of the Third Kind” is more fundamental, and it has to do with re-writing constitutions. This is an “idée fixe” in certain political circles in Mexico. Chile just had its constitutional referendum, and yesterday, newly-inaugurated President of Peru, Pedro Castillo, reiterated that he would seek to do the same via the Constitutional Assembly. So, is Peru leaning left? Most likely yes. But (1) it remains to be seen whether Castillo will have enough votes in the parliament, and (2) the new cabinet’s lineup is likely to have a more immediate market impact. Stay tuned!
Charts at a Glance: U.S. Real GDP Finally Closes COVID Gap
Source: Bloomberg LP