The markets are in a somber mood today, as investors assess growth/inflation policy tradeoffs and China’s growth/COVID challenges.
Global Growth/Inflation Tradeoffs
It’s Day 4 of our research trip to Central Europe, and the deteriorating global sentiment – against the backdrop of upside inflation surprises, growth headwinds and concerns about available policy space – permeates all discussions. Two issues that pop out most frequently are: (1) share of inflation that can be attributed to global factors (=whether central banks can address price pressures without slowing the economy too much); and (2) coordination between monetary and fiscal policies (=growth/inflation trade off). Both issues are relevant not only for EMEA (or wider emerging markets (EM)), but also for developed markets (DM). An example of the latter are growth headwinds in the U.S. created by a combination of fiscal and monetary tightening. By contrast, a more accommodative fiscal stance in Europe might help to mitigate at least some recession risks.
Global/Domestic Inflation Drivers
Central banks emphasized during our meetings that rate hikes can only target a small portion of upside inflation pressures stemming from domestic demand (20% or so). And at times, some of them sounded as if their job (rate hikes) was almost done. However, underestimating the second-round effects from global price shocks can result in falling behind the curve, putting more pressure on local bonds and currencies. We will be having two more rate-setting meetings in other parts of EM this week – Mexico (+50bps expected) and Peru (+50bps expected), and it will be interesting to see how these challenges are addressed by their respective central banks.
China FX Weakness Tolerance Limit
China might be far from Europe geographically, but it is always an important part of regional discussions due to trade connections and the renminbi’s role as a general anchor for many EM currencies. The renminbi continued to creep closer to not-so-magnificent 7 against the U.S. dollar, with another big move today (down by 100bps as of 8:25am ET, according to Bloomberg LP). We maintain that this is the right direction, given the shrinking interest rate differentials with the U.S., capital outflows and near-term growth concerns. However, the speed of the adjustment might be too fast for the central bank, so we would not be surprised to hear more from it in the not-so-distant future. Stay tuned!
Chart at a Glance: Chinese Renminbi’s Depreciation - Too Fast for Comfort?
Source: Bloomberg LP