By Natalia Gurushina Chief Economist, Emerging Markets Fixed Income
The ECB’s 50bps rate hike brought inflation back into focus. So, how high is the bar for rate cuts in EM, where disinflation is well underway?
DM Rate Hikes
The market tried to bounce on the news that Credit Suisse was allowed to borrow from the Swiss National Bank, but concerns about the debacle’s impact on bank lending standards – and, hence, the growth outlook both in Europe and the U.S. – led to some back and forth. The European Central Bank’s (ECB’s) decision to go for a larger 50bps rate hike refocused the market’s attention on economic fundamentals – specifically, persistent price pressures in developed markets (DM), which, according to the ECB, were “projected to remain too high for too long”. The consensus expects headline inflation in Europe and the U.S. to remain outside the target until 2025. The question is whether the U.S Federal Reserve (Fed) will follow suit with a hawkish message next week, or will the banking sector anxieties take precedence? As of this morning, the Fed Funds Futures showed around 70% probability of a 25bps rate increase in March, and implied around 90bps of rate cuts in the rest of the year.
EM Rate Cuts
The policy landscape in emerging markets (EM) is less dramatic these days – aggressive post-pandemic policy tightening means that the real rates are high (=a safety cushion for EMFX), and disinflation is underway in most places. As a result, more and more EM central banks can pause safely (and enjoy the DM show). The Indonesian central bank did just that earlier today – keeping the policy rate on hold and main economic forecasts broadly unchanged. And the Brazilian central bank is expected to do the same next week – with a calmer messaging if the government’s new fiscal framework proposals (expected any day now) look orthodox enough.
EM Disinflation
We consider it a sign of EM resilience that the market continues to price in rate cuts in the next 12 months, despite recent turbulence in DM (see chart below). But we have to admit that the bar for policy easing can be (should be?) high – in part, because the disinflation progress is uneven, core inflation is often sticky and inflation is still far away from the target in many countries. We’ve got some reminders today, as Poland’s core inflation surprised to the upside in February (accelerating to 12% year-on-year), and South Africa’s inflation expectations moved higher in Q1. Actually, several EM central banks might need to tighten a bit more before contemplating a pause – Mexico, and potentially South Africa. Stay tuned!
Chart at a Glance: Implied Rate Cuts in EM – Market Turbulence Notwithstanding
Chart at a Glance: Implied Rate Cuts in EM - Market Turbulence Notwithstanding
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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