Rate Cut Race – Who Goes First?
January 25, 2023
Read Time 2 MIN
The market prices in aggressive rate cuts in some EMs – are these expectations justified?
Rate Cut Expectations
Global central banks are working hard to bring inflation back to targets. This explains actual rate hikes and more implied tightening in emerging Markets (EM (Thailand’s +25bps today, expected +100bps in Colombia later this week)) and developed markets (DM(+25bps by the U.S. Federal Reserve, +50bps by the ECB)). And this is why many central banks remain on high alert (Hungary, Thailand in the past few days) even though peak inflation is behind us. But rate cuts are re-entering our collective market consciousness – and not always to central banks’ liking (the market’s tug-of-war with the Fed). The market expectations for some EMs are also quite aggressive. Hungary and Chile are the frontrunners – with sizable cuts priced in for the next three months. The Czech Republic, India, the Philippines – and possibly Poland and Malaysia – are seen easing in Q2.
China Reopening and Disinflation
The pace of disinflation will be crucial here – peaks might be behind us, but inflation targets are still far away, especially in EMEA and LATAM. Many central banks count on a sharp growth slowdown to reduce price pressures in the coming months. We should also mention “the mother of all base effects” that should provide a powerful technical support to disinflation. The question is whether the consensus underestimates the impact of China’s reopening on commodity prices, as well as the inflationary impact of removing fiscal subsidies that were introduced to shield the population from spiking energy/food prices.
EM Fiscal and External Adjustment
From the market perspective, an important consideration here is that EM policy cushions (the policy rate differentials with the Fed) should reflect existing macroeconomic imbalances, such as fiscal and external gaps (a sum of two is called “twin” deficit). The chart below shows why the market is so preoccupied with Brazil’s populist policy shift (which can slow/reverse fiscal adjustment), and why the Brazilian central bank might feel constrained in its ability to cut rates despite successful disinflation and the highest real policy rate in EM. On the other hand, if Chile’s current account gap improves faster on the back of China’s rebound or we get positive surprises in Hungary’s fiscal performance, the market expectations for sizable rate cuts in these countries might turn out realistic after all. Stay tuned!
Chart at a Glance: Importance of Adequate Policy Cushions
Source: VanEck Research; Bloomberg LP.
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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.
The information presented does not involve the rendering of personalized investment, financial, legal, or tax advice. This is not an offer to buy or sell, or a solicitation of any offer to buy or sell any of the securities mentioned herein. Certain statements contained herein may constitute projections, forecasts and other forward looking statements, which do not reflect actual results. Certain information may be provided by third-party sources and, although believed to be reliable, it has not been independently verified and its accuracy or completeness cannot be guaranteed. Any opinions, projections, forecasts, and forward-looking statements presented herein are valid as the date of this communication and are subject to change. The information herein represents the opinion of the author(s), but not necessarily those of VanEck.
Investing in international markets carries risks such as currency fluctuation, regulatory risks, economic and political instability. Emerging markets involve heightened risks related to the same factors as well as increased volatility, lower trading volume, and less liquidity. Emerging markets can have greater custodial and operational risks, and less developed legal and accounting systems than developed markets.
All investing is subject to risk, including the possible loss of the money you invest. As with any investment strategy, there is no guarantee that investment objectives will be met and investors may lose money. Diversification does not ensure a profit or protect against a loss in a declining market. Past performance is no guarantee of future performance.
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.
The information presented does not involve the rendering of personalized investment, financial, legal, or tax advice. This is not an offer to buy or sell, or a solicitation of any offer to buy or sell any of the securities mentioned herein. Certain statements contained herein may constitute projections, forecasts and other forward looking statements, which do not reflect actual results. Certain information may be provided by third-party sources and, although believed to be reliable, it has not been independently verified and its accuracy or completeness cannot be guaranteed. Any opinions, projections, forecasts, and forward-looking statements presented herein are valid as the date of this communication and are subject to change. The information herein represents the opinion of the author(s), but not necessarily those of VanEck.
Investing in international markets carries risks such as currency fluctuation, regulatory risks, economic and political instability. Emerging markets involve heightened risks related to the same factors as well as increased volatility, lower trading volume, and less liquidity. Emerging markets can have greater custodial and operational risks, and less developed legal and accounting systems than developed markets.
All investing is subject to risk, including the possible loss of the money you invest. As with any investment strategy, there is no guarantee that investment objectives will be met and investors may lose money. Diversification does not ensure a profit or protect against a loss in a declining market. Past performance is no guarantee of future performance.