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By Natalya Gurushina
Chief Economist, Emerging Markets Fixed Income

EM and DM tightening cycles become less synchronized. Can EMs handle earlier exits and rate cuts?

A global austerity cycle

The market is still digesting The unexpected decision by the Bank of Japan (BoJ) to widen the scope of the yield curve controls, which reaffirmed all key interest rates and boosted the Japanese yen to 335 bps against the US dollar. The immediate question is whether today’s move and the prospect of further adjustment sends a bearish signal for global stocks. While outgoing governor Kuroda insists it’s not a policy tightening (the BoJ has simultaneously pledged to increase bond purchases), the market could be forgiven for thinking the BoJ will blink again. As for emerging markets (EM), we saw no major changes in market expectations for EM policy rates this morning, and EM FX performed quite well.

EM policy rate differentials

However, Japan’s hawkish maneuver draws attention to the fact that the current tightening cycle in EM is not as synchronized with developed markets (DM) as before. Most EM central banks started tightening much earlier than their DM counterparts, but major central banks picked up the pace in 2022. US Federal Reserve actually Outperformed most EMs in Q4, compressing policy rate differentials with all EM regions (see chart below). This may be less of an issue in LATAM, where the policy gap is still the widest. However, it remains to be seen whether this will be enough to offset the political noise and political uncertainty in the region. For example, Brazil’s swap curve continues to rise with a small “warning shot” rate hike in early 2023 to address the new administration’s spending plans.

EM prices and China’s reopening

The policy rate differential between EM Europe and the Fed is still higher than pre-pandemic levels. Central Europe is no longer in a growth mood (Hungary stalled today and the Czech Republic is likely to follow suit tomorrow), but uncertain inflation paths and continued concerns about post-election fiscal adjustments and pre-election changes in Hungary. Fiscal opulence in Poland creates additional risks. EM Asia’s policy rate differential with the Fed is the smallest, less than 100bps, and this “cushion” may be too thin, until we see more capital inflows aimed at benefiting from China’s reopening theme. Stay with us!

Chart at a glance. EM policy rates “Cushion” – Quite large.

Source: VanEck Research; Bloomberg LP.

From the beginning published By VanEck on Dec 20, 2022.

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PMI – Purchasing Managers’ Index. economic indicators obtained from monthly surveys of private sector companies. A reading above 50 indicates expansion and a reading below 50 indicates contraction; ISM – Institute of Supply Management PMI. ISM publishes an index based on surveys of more than 400 purchasing and supply managers; in both manufacturing and non-manufacturing industries; CPI – Consumer Price Index. an index of variation in prices paid by ordinary consumers for retail goods and other goods; PPI – Producer Price Index. a family of indices that measure the average change over time in the selling prices received by domestic producers of goods and services; PCE inflation – Price index of personal consumption expenses. One measure of U.S. inflation, tracking changes in the economy-wide price of goods and services purchased by consumers; MSCI – Morgan Stanley Capital International. an American provider of equity, fixed income, hedge fund stock market index and equity portfolio analysis tools; VIX – CBOE volatility index. An index created by the Chicago Board Options Exchange (CBOE) that shows the market’s 30-day expectation of volatility. It is constructed using the implied volatilities of the S&P 500 Index options. GBI-EM – JP Morgan Government Bond Index – Emerging Markets. comprehensive emerging market debt benchmarks that track local currency bonds issued by emerging market governments; EMBI: – JP Morgan Emerging Market Bond IndexJP Morgan’s dollar-denominated sovereign bond index issued by a number of emerging market countries; EMBIG – JP Morgan’s Emerging Market Bond Index Global. tracks total returns on foreign debt instruments traded in emerging markets.

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