Emerging Markets Debt Daily
Policy Response and Growth/Rates DichotomyNatalia Gurushina, Chief Economist, Emerging Markets Fixed Income StrategyJuly 20, 2021
Lower global rates contrast with optimistic growth forecasts. EMs are expected to continue hiking, which should help to bring the average EM real policy rate back to positive territory in early 2022.
The decline in the U.S. Treasury yields looks relentless – the 10-year yield was down to the 1.13-1.14% handle this morning. And it contrasts sharply with the consensus outlook for the U.S. GDP growth – the 2021 forecast is still unchanged at 6.6% (despite concerns about the virus mutations), and the 2022 forecast was recently raised for to 4.2%. The outlooks for other major global growth drivers (China and the Eurozone) also look fine. The dichotomy between the rates’ dynamics and the growth outlook explains heightened interest in the upcoming policy communications by the European Central Bank (ECB, on July 22) and the U.S. Federal Reserve (July 28).
Meanwhile in emerging markets (EM), China’s decision to keep both 1-year and 5-year Loan Prime Rates on hold was widely interpreted as a sign that the growth downside is limited, so “sharper” policy turns can be avoided for now. The next big test will come at the end of the month, when we get China’s activity gauges (PMIs) for July. As a reminder, China’s real policy rate is among the highest in the world (see chart below), so there is room for further adjustment (if necessary).
The chart below also shows that the average real policy rate in EM ex-China is still very much negative, despite the recent hikes. This is because EM inflation has been trending up as well. And this means that the “policy cushion” for some assets – such as currencies – is still thin. The consensus sees more rate hikes in EM going forward, but the expectation is that the fading low base effect in prices will be disinflationary (other things equal). Under this scenario, the average real policy rate in EM ex-China should be back in positive territory by Q2-2022.
Charts at a Glance: Policy Response and Growth/Rates Dichotomy
Source: VanEck Research; 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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