Natalia Gurushina, Chief Economist, Emerging Markets Fixed Income Strategy
August 25, 2020
The consensus does not think that recovering growth and bottoming inflation justify major rate hikes in EM. Brazil’s external balance remains solid, but fiscal/political noise limit the market impact.
There are more signs that the emerging markets (EM) growth is turning and inflation is bottoming. The question is what’s next for EM rates. At the moment, the consensus is not expecting too many rate hikes in EM in 2021 (see chart below). But there are some notable exceptions. One exception is Brazil—the consensus sees around 40bps of hikes, with concerns about fiscal performance/agenda being an important driver. Another exception is Turkey—the consensus thinks that the central bank will be forced to abandon its current strategy of “backdoor” tightening via the average cost of funding and hike the benchmark rate by 100bps.
Brazil’s fiscal trajectory might be questionable, but its external balance remains solid. The country posted a larger than expected current account surplus in July (USD1.63B) and stronger than expected foreign direct investment inflows (USD2.69B). In theory, a combination of strong inflows and the improving growth outlook should strengthen the fundamental support for the currency. However, for this to materialize, the market would need more clarity on the government’s reform agenda and less political noise.
Mexico’s current account improved in Q2, but not as much as expected. The surplus was barely detectable (USD0.005B), with both exports and imports hit by the COVID restrictions. Stronger domestic high-frequency indicators point to Q3 recovery in consumption—and hence in imports—which can cap near-term current account improvements. Today’s reports that crude oil production at state-owned Pemex dropped to a 41-year low point in the same direction (but from the exports side).
Chart at a Glance: Consensus Does Not See Too Many Rate Hikes in EM
Source: Bloomberg LP
IMPORTANT DEFINITIONS & DISCLOSURES
PMI – Purchasing Managers’ Index: economic indicators derived from monthly surveys of private sector companies; 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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