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Lower Rates, Higher Risks?

March 14, 2023

Read Time 2 MIN

Should the concept of EMs as a safer haven get more acceptance after the latest market “hiccup”? A growing number of EM Graduates and EMs’ own independent growth driver (China) point in this direction.

Fed Pivot

Yesterday’s massive short squeeze in global short rates – which produced the largest daily drop in the 2-year U.S. Treasury yield since 1983 (ahead of the 1987 Black Monday, the aftermath of 9/11, and the 2008 global financial crisis) - seems to be over, but concerns about the state of the banking system at large are still here. And this helps to explain an abrupt shift in the market expectations for major global central banks, even though inflation pressures are might not be receding fast enough. As of this morning, the Fed Funds Futures were pricing in less than 40bps of remaining rate hikes in the U.S. (in March or May), the implied Fed peak rate stayed below 5%, and the implied H2 rate cuts staged a comeback (see chart below). The U.S. Federal Reserve’s meeting next week will be very interesting indeed.

China Growth Outlook

It remains to be seen whether the banking sector concerns will affect the growth outlook in DM, but many emerging markets (EMs) must be grateful to have an independent global growth driver in their midst – China. The China commentary focused mostly on political/geopolitical issues and longer-term strategic policy items in the past few days (after the National People’s Congress). Still, today’s domestic activity indicators (retail sales, investments, industrial production, and residential property sales) will be closely watched for further signs of recovery – both the speed and the type (consumption-driven or not).

EM Graduates

The China factor might have shielded some EMs during the selloff, but the past week's events also raised another – perhaps even more ambitious – question. Should a concept of EMs as a safer haven be getting more acceptance going forward? Of course, the EM family has its “enfants terribles” – just check Argentina’s 3-digit inflation numbers this afternoon (if you dare) or look at Turkey’s rate cuts “shenanigans.” However, EM Graduates are growing in numbers, and these are the countries who had done their “homework” – including implementing structural reforms, having independent central banks, and targeting international reserves rather than exchange rates - after the past crises. Many of them also pay much higher real rates than DMs. Stay tuned!

Chart at a Glance: Market Expectations for the Fed – Running Scared

Chart at a Glance: Market Expectations for the Fed - Running Scared

Source: Bloomberg LP.

PMI – Purchasing Managers’ Index: economic indicators derived from monthly surveys of private sector companies. A reading above 50 indicates expansion, and a reading below 50 indicates contraction; ISM – Institute for Supply Management PMI: ISM releases an index based on more than 400 purchasing and supply managers surveys; both in the manufacturing and non-manufacturing industries; CPI – Consumer Price Index: an index of the variation in prices paid by typical consumers for retail goods and other items; PPI – Producer Price Index: a family of indexes that measures the average change in selling prices received by domestic producers of goods and services over time; PCE inflation – Personal Consumption Expenditures Price Index: one measure of U.S. inflation, tracking the change in prices of goods and services purchased by consumers throughout the economy; MSCI – Morgan Stanley Capital International: an American provider of equity, fixed income, hedge fund stock market indexes, and equity portfolio analysis tools; VIX – CBOE Volatility Index: an index created by the Chicago Board Options Exchange (CBOE), which shows the market's expectation of 30-day volatility. It is constructed using the implied volatilities on S&P 500 index options.; GBI-EM – JP Morgan’s Government Bond Index – Emerging Markets: comprehensive emerging market debt benchmarks that track local currency bonds issued by Emerging market governments; EMBI – JP Morgan’s Emerging Market Bond Index: JP Morgan's index of dollar-denominated sovereign bonds issued by a selection of emerging market countries; EMBIG - JP Morgan’s Emerging Market Bond Index Global: tracks total returns for traded external debt instruments in emerging markets.

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