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Rate Hikes – Greater Sense of Urgency

May 18, 2022

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The consensus expectations are shifting towards earlier tightening cycles in EM Asia. South Africa is likely to step up rate hikes despite inflation still in the target range.

Global Rate Hike Expectations

The U.S. Federal Reserve seems to have settled into a +50bps pace of rate hikes – this is what the market currently sees for the next 3 meetings, but the expectations for the European Central Bank (ECB) are still on the move, with +30bps (each) priced in for July and September (and some analysts are asking what it would take for the ECB to hike by 50bps!). In emerging markets (EM), the focus is gradually shifting to Asia, where we had some hawkish monetary policy surprises lately, and inflation pressures continue to rise. Local swap curves price in additional 90bps of tightening in India in the next 3 months (on top of the inter-meeting rate hike) and the inaugural 25bps hike in Thailand. The consensus also thinks that the central bank of the Philippines will start the liftoff tomorrow, as headline inflation breached the official target.

South Africa Inflation, Pace of Rate Hikes

At the moment, only three major EMs have their inflation within the official target ranges – one of them is South Africa (see chart below). South Africa’s headline inflation remained unchanged in April (5.9% year-on-year), as expected, but the central bank is likely to step up the pace of rate hikes tomorrow to 50bps, because core inflation continues to grind higher, and there are concerns that this might start affecting inflation expectations.

‘Twin Deficit’ Problem in EM

Rising global rates can create problems for EMs with large fiscal deficits and widening/large current account gaps (South Africa is not one of them, by the way) – both in terms of more expensive financing and also because higher rates can drive headline fiscal deficits wider. Chile is among the countries on our “twin deficit watch list” – which also includes Hungary, Colombia, the Philippines, and Turkey – and, unfortunately, its Q1 current account deficit (released this morning) was larger than expected (USD5.575B). The slowing economy (the real GDP growth was negative in Q1 – for the first time since the pandemic) should lead to some current account correction going forward, but in the meantime, large “twin” deficits will continue to weigh on the currency (denting local bonds’ total return).

Chart at a Glance: EM Inflation – Moving Further Away from Target

Chart at a Glance: EM Inflation – Moving Further Away from Target

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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