EM – Already Thinking about Rate Cuts?
January 27, 2022
Read Time 2 MIN
The market believes that aggressive rate hikes in parts of EM will be followed by rate cuts later in 2022, as growth falters and disinflation kicks in.
“Hawkish” Surprises in EM and DM
This might be a strange question to ask after seemingly hawkish holds in the U.S. and Canada, an expected rate hike in South Africa, a surprising rate hike in Kazakhstan and an even bigger hawkish surprise in Chile – but please bear with us. Let’s look at developed markets (DM) first. The “hawkish” bit in the U.S. came from U.S. Federal Reserve (Fed) Chairman Jerome Powell’s remark that the policy rate can be raised at every meeting – this makes potentially 7 hikes in 2022 instead of 4 priced in by Fed Funds Futures before yesterday’s meeting. When we checked our Bloomberg screens this morning, however, Fed Funds Futures showed only a slightly higher implied rate hike in March (30bps) and about 4.5 of hikes in total for 2022 – not a big change. The release of the advanced Q4 GDP print in the U.S. might explain the market’s hesitation – even though the annualized quarterly growth rate was much higher than expected (6.9%), about two-thirds came from higher inventories (which is not the best ratio).
EMs Keep Frontloading Rate Hikes
Meanwhile in emerging markets (EM), the market was taken by surprise by a gutsy 150bps rate hike in Chile. The fact that the central bank chose to frontload more tightening is understandable – the economy shows signs of overheating (economic activity shows double-digit growth, fueled by multiple withdrawals from private pension funds and government spending – see chart below), headline inflation surged to 7.2% year-on-year and the budget deficit was close to 8% of GDP last year. However, a combination of the lagged impact of rate hikes and sizable fiscal adjustment (budget deficit narrowing to around 4.2% of GDP in 2022) is expected to bring Chile’s real GDP growth down from 11.5% in 2021 to mere 2.5% in 2022. What would the central bank do in this situation? The market thinks that it will be forced to reverse its policy and start easing in 6-12 months.
Dovish Rate Expectations in EM
Apparently, Chile is not the only major EM – outside of China (where small rate cuts are expected in 3-6 months) – where the market now expects the return of the doves. Brazil might be on a similar path in LATAM. In Emerging Europe, Poland, Russia and the Czech Republic are also expected to lower policy rates in 6-12 months. Rate hikes in DM/U.S. vs rate cuts in EM – that would be an interesting scenario for H2-22. Stay tuned!
Charts at a Glance: Chile Growth – Surging beyond Low Base Effect
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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