Emerging Markets Debt Daily
EM Policy Contagions - From Good to ControversialNatalia Gurushina, Chief Economist, Emerging Markets Fixed Income StrategyJuly 29, 2021
A tame Fed provided a much-needed market respite, and EM with strong policy frameworks are set to benefit. As this happens, be mindful of EM policy “contagions” of another kind, which can be less forgiving.
A prospect of China’s tech contagion spooked the market big time earlier this week, but it looks like a combination of some local damage control, a tame U.S. Federal Reserve (Fed) and the fact that U.S. GDP finally exceeded the pre-pandemic level in real terms (see chart below) provided a much needed respite. This might be a good moment to talk about another kind of emerging markets (EM) contagion - policy “contagions” - and we start with the one that is outright good. “EM Policy Contagion of the First Kind” is the proliferation of orthodox monetary policies across EM. The most obvious manifestation, at this moment, is the frontloading of EM rate hikes in order to cap inflation risks (and not because of the Fed). The Czech National Bank might be the next in line after some board members called for more aggressive tightening. Even the Turkish Central Bank sounded cautious in its just-released quarterly inflation report. If you check today’s EM FX performance ranking, many currencies with “aggressive” central banks behind them are in the lead.
“EM Policy Contagion of the Second Kind” has some populist connotations and should be watched closely. We are talking about withdrawals from private pension funds to ease near-term economic hardship. LATAM currently dominates the headlines, but now it looks like South Africa really liked the idea and might soon join the club. The immediate market impact of these measures is more ambiguous - especially in countries where pension funds’ assets are huge as a percentage of GDP (like in Chile or South Africa). But the longer-term impact from multiple withdrawals on the fiscal trajectory and local debt and equity markets could be negative.
“EM Policy Contagion of the Third Kind” is more fundamental, and it has to do with re-writing constitutions. This is an “idée fixe” in certain political circles in Mexico. Chile just had its constitutional referendum, and yesterday, newly-inaugurated President of Peru, Pedro Castillo, reiterated that he would seek to do the same via the Constitutional Assembly. So, is Peru leaning left? Most likely yes. But (1) it remains to be seen whether Castillo will have enough votes in the parliament, and (2) the new cabinet’s lineup is likely to have a more immediate market impact. Stay tuned!
Charts at a Glance: U.S. Real GDP Finally Closes COVID Gap
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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