Rate Lesson Absorbed Fighting Mini-Feds
Soaring US Treasury yields and inflation fears in developed markets more generally are speeding rate hikes in select emerging markets as inflation ticks up on commodity price rises and currency falls. In just a week Turkey, Brazil and Russia hiked rates, the last a market surprise while Brazil and Turkey raised rates more than expected. Despite the bond market turmoil, strategic and retail portfolio inflows continue to be strong. Year-to-date into EM bonds they reached USD 27.7 billion, of which nearly 60% has gone into local currency debt, while equity funds have taken in USD 65.8 billion, according to EPFR Global data. The MSCI EM Index is up 4.3% in USD terms year-to-date, while on JPMorgan’s indices both local currency and FX bonds are down about 5%.
Signs of recovery from the Coronavirus pandemic are emerging with vaccine production and rollout but the rebound will be unequal. However, liquidity will continue to flow, benefitting emerging markets. The US Federal Reserve and European Central Bank have committed to maintaining low rates and balance sheet expansion. In this week’s meeting the Fed strongly stated that it will continue to support the US economy “for as long as it takes,” in a phrase reminiscent of former ECB head Mario Draghi pledge to “do whatever it takes” to rescue the eurozone at the height of the crisis in July 2012. Despite the marginal uptick, negative yielding government debt stock still stands at USD 13 trillion as of mid-March, according to JPMorgan data, of which nearly half is from the EMU.
The OECD, in its March outlook forecast, projects global growth will rebound to 5.6% this year following 2020’s 3.4% contraction. EM giants India and China will lead the rebound, with economic expansion projected at 12.6% in FY 21/22 for the former and 7.8% this calendar year for the latter. The IMF in January projected global growth at 5.5% this year, with emerging and frontier markets expected to expand at 6.3% and 5.1%, respectively, far outpacing developed economies’ likely 4.3% expansion.
Many emerging and developed economies alike heeded former austerity champions the IMF and OECD to “spend as much as you can” to fight the virus, in the words of the former, while the latter cautioned that renewed austerity or tax hikes could cause the public to revolt if governments try to quickly return debt and deficits to pre-pandemic levels. While some emerging markets may face balance of payments or fiscal crises this year after massive borrowing and stimulus programs, average overall emerging market debt/GDP is some 50% lower than developed country counterparts and IMF data puts EM budget deficits for 2020 at 6% of GDP while the average in developed markets was 11%. In 2020 gross sovereign issuance by EM in hard currencies reached USD 230 billion and EM corporates issued over twice that amount nearly USD 500 billion, both up more than 20% over a year earlier on cheap borrowing costs
In addition to grappling with debt and deficits, many EMs will struggle with inflation this year. Food prices are soaring globally – and food makes up a greater percentage in CPI baskets in EM than in DM – while oil prices have soared some 70% since late 2020 despite this week’s fall. Markets that are massively dependent on energy imports like Turkey and India will be pressured, as will countries like Egypt which is the world’s biggest buyer of wheat. Producer price inflation in China, the world’s most important buyer of commodities, soared 1.7% year-on-year in February, although CPI is still in negative territory largely on falling pork prices. Year ago comparisons in China and elsewhere are hardly indicative of future trends in many markets now due to pandemic shutdowns last year.
Even with the uptick in UST yields and commodity price-induced inflation, dedicated and cross-over investors will continue to direct allocation to many emerging markets this year with greater differentiation. One illustration is Brazil’s 10% stock market and 7%+ currency fall so far this year on debt, deficit, and policy concerns in contrast to Latin neighbor Chile’s 16% stock market and 12% currency advance on soaring copper prices. In addition to traditional macro-economic considerations – like GDP growth, inflation, debt, and deficit levels – policy, politics, and geopolitical issues are becoming increasingly critical to weigh as investors must add issues like global trade flows with supply chain reinvention and the potential impact of sanctions. The embrace of ESG has also become a critical decision-making factor. The “E” – environment – was in the spotlight pre-pandemic, but now the “S” and “G” are equally important in the wake of Covid-19 which highlighted social inequalities worldwide and the need for good governance for basic public service delivery. While the global economy begins to recover from the Covid-induced recession, this week investor decision-making became more complicated as the full range of global and single country “top down” macro-economic and political/geopolitical/policy analysis is sifted through the tangle of benchmark rate and institutional credibility pressures even with headline price stability and legal independence.