As the well-loved noughties skater-pop song once asked; why'd you have to go and make things so complicated?
This week has been undoubtably complicated for risk assets in general, which has fed into the emerging markets. Market participants continue to face a confluence of headwinds, including an increasingly hawkish Fed, bottlenecks in the energy markets, concerns over the debt ceiling in the U.S, ongoing growth moderation in China and the resulting debate over “peak” global growth. As such, price action in emerging markets (EM) has indeed been weak over recent days; while local rates have held in admirably, external debt and EMFX have felt the heat. One of our sell-side contacts described client outflows in our asset class as the worst seen since the Q1 rout earlier this year. At the same time, market participants have been faced with a number of EM central bank decisions, which have further clouded the picture this week.
Earlier in the week, the Bank of Thailand (BoT) held the benchmark interest rate at 0.50% at its September meeting. While this decision was in line with consensus, we note a subtle hawkish surprise in the Monetary Policy Committee (MPC) vote composition; compared with the August decision, where two members voted for a rate cut, this month, the decision to hold was unanimous. Likewise, the MPC revised up its growth forecasts for 2022; the delta infection wave has shown signs of improvement and lockdown restrictions have been eased.
Elsewhere this week, the Czech National Bank (CNB) raised its interest rate by 0.75% to 1.50%, contrary to expectations of a 0.50% hike. The CNB continues to front load its tightening cycle, in response to ongoing upside Consumer Price Index surprises, with the August print at 4.1% even further above the central bank target band of 2% +/- 1%. The accompanying statement was undoubtably hawkish, where the central bank governor suggested that they will act “decisively” in the face rising inflation risks which are likely to be prevalent for “several quarters”.
Similarly, the Banco de Mexico (Banxico) met this week, where they increased the base rate by 0.25% to 4.75%, in line with market expectations. We note a marginally hawkish shift in terms of the vote split; this time there was only one dissenter (4-1), compared with two at the previous rate hikes this year (3-2). At the same time, Banxico revised up its inflation outlook for Q4, with headline inflation now expected at 6.2%, compared with 5.7% previously. While there are certainly hawkish signals from this week’s meeting, the MPC remains wed to the view that domestic inflation is transitory in nature; we believe that rate hikes will be slow and data dependent.
Elsewhere this week, Banco de la Republica (BanRep) finally joined the LATAM tightening cycle, unanimously voting to hike rates by 0.25% to 2%, which was in line with consensus expectations. That said, there was a hawkish surprise, with three board members out of seven voting for a 0.50% rate rise. The hawkish tone was also clear in the post-decision forecast revisions, with the Gross Domestic Product and inflation outlook revised up for this year and next. The hawkish shift on the board opens up the prospect of accelerated rate hikes in Colombia; in our view, BanRep is behind the curve and a clear laggard in the LATAM space.
Looking forward, we do not expect a “taper tantrum”; the market consensus is already very bearish when it comes to EM, which is reflected in conservative positioning in both rates and EMFX. Furthermore, while we are cautious when it comes to the upcoming Fed taper announcement, it has been so well telegraphed it may ultimately prove to be a non-event. As outlined in our emerging market monthly research piece, Taking Stock – Diverging Paths in EM, we believe that the monetary policy divergence that we have seen much of this year and, indeed, this week, is set to continue. As such, we believe there are selective cross market opportunities within our asset class; we target these positions in two ways; (1) we look to generate alpha from positioning in markets where the policy tightening cycle is maturing, relative to those who have barely began; and (2) we focus on longer term market pricing undershoots and overshoots relative to central bank estimates of the neutral rate. The aforementioned monthly piece explores this monetary policy divergence in more detail and outlines our favoured positions as we enter the final months of the year.
Taking Stock - Diverging Paths in Emerging Markets
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