EM Policies Matter – We Have Proof
October 22, 2021
Read Time 2 MIN
Russia’s gutsy rate hike and fiscal frugality contrast sharply with Turkey’s larger than expected cut and Brazil’s fiscal uncertainty. The currencies’ recent diverging performance is a reflection of diverging policies.
Emerging markets (EM) FX performance this morning is a great illustration of our motto “EM is not a monolith”. It also shows that the market does differentiate between good and bad EM policies. The Russian ruble and the Mexican peso are leading the currency pack. Russia’s central bank delivered a gutsy 75bps rate hike this morning - that was only 1/3 priced in (25bps) - and signaled that there could be more tightening in the future if inflation pressures do not subside. Mexico’s rate-setting meeting is in early November, but the central bank’s recent reaction function suggests that it might go for another measured rate hike following today’s upside surprise in bi-weekly inflation (especially in core inflation).
The Turkish lira and the Brazilian real are firmly in the red this morning. The lira is still reeling from yesterday’s bigger than expected rate cut, hitting another historic low against the U.S. Dollar. The U.S. Financial Action Task Force (FATF) decision to add Turkey to its “gray list” of high-risk and non-cooperative jurisdictions did not help either. A major risk is that the rate cut and the resulting currency weakness will add to inflation pressures (the central bank’s credibility is low, so FX-inflation pass-through is high), creating a negative feedback loop. In addition, lower funding costs are likely to re-accelerate credit growth, bringing back overheating concerns.
Brazil’s descending into another policy/political mess is the main reason for the real’s underperformance. First, it looks like authorities will go ahead with a larger social program, part of which might be financed outside the spending cap. Second, there is a proposal to change how the spending cap is calculated. Finally, several top Treasury officials – some of whom just met with investors during the IMF Annual Meetings - had had enough and submitted their resignations yesterday. The government’s “market friendly” face – Economy Minister Guedes – said that he will stay. But his reason – not to worsen the crisis – is hardly reassuring. Brazil’s bond vigilantes are back, with the 10-year government bond yield reaching 12% this week (7% back in January). And the markets now expect the central bank to be a “heavy-lifter”, and accelerate the pace of tightening to 150bps next week and in December. Governor Campos Neto indicated a few weeks ago that he would do whatever it takes to bring inflation back under control – will he deliver? Stay tuned!
Chart at a Glance: Today’s EMFX Performance Is A Reflection of Policy Divergence
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.
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.
June 24, 2022
We are seeing some EM “green shoots” in the predominantly negative global growth dataflow. Can EMs buck the DM trend for much longer?
June 23, 2022
Global rates rally on recession concerns following weak activity gauges in DM, but some EM central banks do not yet have the luxury of slowing the pace of rate hikes.
June 22, 2022
Have EMs done enough policy tightening? This remains an important question as DMs act more hawkish and EM inflation prints leave official target ranges at an alarming pace.
June 21, 2022
Colombia elected a leftist President, but what about the cabinet lineup? Brazil is expected to wind down its tightening cycle – despite hawkish minutes.