Rates Higher – But For How Long?

Fed Rate Hikes

The morning’s big story is global rates pushing higher, with the 2–year U.S. Treasury yield approaching 4% and the 30–year mortgage rate testing the 2008 highs (with ensuing concerns about the housing market and the growth outlook). All eyes are now on tomorrow’s U.S. Federal Reserve (Fed) policy announcement – Fed Funds Futures continue to price in a small probability of a larger 100bps hike and a terminal rate of around 4.5% (in early–2023). Emerging markets (EM) duration remains under pressure in this environment – positive monthly spread returns being too small to compensate for much larger Treasury losses, especially for longer–dated bonds (see chart below).

EM Tightening Cycles

The policy drumbeat in some EMs is still hawkish. South Africa and Mexico are widely expected to maintain the pace of tightening with 75bps rate hikes this month. Hungary might frontload more next week due to persistent inflation pressures, and also to create an extra policy buffer as the latest political spat with the European Union can lead to sizable EU funding cuts. However, EM regional policy rate aggregates are definitely peaking, and the winding down narrative is gaining weight. Brazil’s rate–setting meeting tomorrow will be an important litmus test. The consensus expects the central bank to remain on hold, and the local swap curve now prices in gradual rate cuts starting from Q2.

China Policy Easing

Some EMs are easing outright, but China is perhaps the only one where policy easing actually makes sense, because inflation pressures are non–existent and the near–term growth outlook is still deteriorating. Authorities, however, appear to have taken a pause in the run up to the Communist Party Congress in October. All policy rates were kept on hold in September – including today’s loan prime rate. Reports also point to a hiatus in special local government bond issuance after a big jump in Q2. We (and the market) keep an eye on the next batch of China’s activity gauges – the August numbers were not particularly conclusive, despite some improvements. Stay tuned!

Chart at a Glance: A Bad Month for EM Duration

Source: Bloomberg LP.

Note: EMBIG – J.P. Morgan’s EMBI Global Diversified Index.