Guardrails Up!

Global QT

Some emerging markets (EM) are trying to stay in a “business as usual” mode (Thailand’s leisurely 25bps rate hike), but sharp asset price moves and surprising policy U-turns in developed markets (DM) raised questions about EMs’ ability to stay on the sidelines. The Bank of England’s decision to abandon its quantitative tightening (QT) plans and start buying long-dated government bonds to stabilize the market after this week’s massive selloff had an immediate impact – the 30-year U.K. yield narrowed by 107bps following the announcement. However, it also led to multiple “Japanification/policy contagion” comments. The market also made a small adjustment in its expectations (measured by Fed Funds Futures) for the next policy rate hike in the U.S. (to 65bps), as well as for the Federal Reserve’s terminal policy rate (4.4%).

China Currency

J.P. Morgan’s EM FX index bounced after the initial morning weakness, but some currencies required more support than others. China’s central bank resorted to verbal intervention after the renminbi broke through 7.20/U.S. Dollar to the weakest level since 2007 (see chart below). Some reports also suggested that authorities might bring back the counter-cyclical factor in the daily currency fixings to reduce volatility. The renminbi’s moves are affected both by the U.S. Dollar’s general strength (“safe haven” status, a more favorable interest rate differential with major currencies) and China’s policy divergence (easing while the rest of the world is tightening). The latter reflects China’s worsening near-term growth outlook, which is why the official activity gauges for September – to be released on Thursday - will be closely watched.

EM Rate Hikes

EM’s ability to conduct independent monetary policy – rather than to follow in lockstep with DMs - will be tested in this environment. And this includes tomorrow’s rate-setting meetings in Mexico, Colombia, and the Czech Republic. Given Mexico’s never-ending upside inflation surprises, the central bank might have no other choice but to deliver another sizable 75bps rate hike. The Czech National Bank was trying to make a dovish turn by keeping its policy rate on hold in August – the market continues to see room for a small rate cut, but only in a few months. Stay tuned!

Chart at a Glance: CNY Weakness Continues*

Source: Bloomberg LP