Reviewing Our 2023 EM Assumptions

EM Tightening Cycle

Emerging markets’ (EM’s) credible and pro-active policy response to rising price pressures and China’s rebound are among key factors underpinning our 2023 outlook for EM bonds. How have these assumptions been holding so far this year? EM monetary authorities are passing with flying colors. EM inflation is moderating, but various central banks are not taking any chances and staying cautious, as the process of disinflation is rather bumpy and might take longer than previously thought. Mexico and the Philippines raised their respective policy rates by more than expected earlier this month, and even central banks that stayed on hold signaled that the bar for rate cuts is very high. The latest hawkish surprise came from Israel, where the central bank opted for a larger 50bps rate hike yesterday, instead of expected 25bps, and signaled more tightening, because activity and inflation turned out much stronger than expected.

China Rebound

EMs’ relatively high real interest rates (vs. developed markets (DM)) provide a nice policy cushion against the (potentially) more hawkish U.S. Federal Reserve (Fed), but for this cushion to translate into actionable trades, a decent growth outlook is often a must. China’s rebound is an important driver here, and various gauges/high frequency indicators show that domestic activity is definitely bottoming out. We are also hearing about additional policy measures to prop up the housing sector and promote bank lending – such as draft new rules on banks’ risk-weighting and a pilot scheme to allow real estate investments by private equity funds. Still, there are plenty of questions about the recovery’s timeline – especially as regards consumption. A recent sell-side report suggested that excess savings might be smaller and partly used for precautionary purposes. Further, the use of excess savings might be slower initially, pushing the recovery to H2/early 2024.

Global Growth Outlook

China is not the only growth story we are watching – the growth outlook in advanced economies is also important, especially for more open EMs (note that the economic surprise index for EM exports is still in the red – see chart below). February’s preliminary activity gauges for the Eurozone (PMIs, or Purchasing Managers Indices) looked mixed – a very strong reading for the services PMI (53.0), but the manufacturing PMI (48.5) remains contractionary. The U.S. PMIs looked almost as “conflicted” – the expansionary services PMI and the contractionary manufacturing PMI – except that manufacturing was better than expected. There was nothing in the release to suggest that the Fed should stop hiking – so, it’s good that EM central banks are en garde. Stay tuned!

Chart at a Glance: EM Export Surprises – Still in the Red

Source: Bloomberg LP.

Citigroup Economic Surprise Index (CESI) tracks whether a core set of economic data series has been coming in under expectations, at expectations, or over expectations.