Peak rate – Beware of the tax gap
By Natalia Gurushina
Chief Economist, Emerging Markets Fixed Income
Fiscal considerations will play a bigger role in emerging market central bank decisions going forward, which will provide more leeway to slow the pace of increases or lead to further tightening.
The End of EM Tightening Cycles
Tomorrow’s European Central Bank (ECB) rate-setting meeting will be the focus of the week. A 75 basis point hike and the 3% terminal rate are firmly entrenched in price, but the press conference and guidance will be just as important – both for interest rates (including the shape of the yield curve) and for the euro, which has staged a mini rally in recent days. In emerging markets (EM), all eyes are on Brazil, where the central bank is set to begin its next chapter by keeping the key rate unchanged this afternoon at 13.75%. The central bank’s proactive response has created a huge political cushion (Brazil’s real ex-ante policy rate is around 8%!) that has provided the fundamental support for the currency and local debt this year. Year-to-date, the total return of JP Morgan’s GBI-EM Brazil index (US dollar unhedged) is not only positive, but significantly outperforms the others (with the exception of Turkey – see the graph below). However, whether or not this outperformance can be extended in the future will also depend on the outcome of Sunday’s run-off (polls show a technical tie) and its impact on the political agenda – particularly on the front budget, where Brazil performed admirably in 2022.
Fiscal adjustment in South Africa
The market is also closely watching the pace of fiscal adjustment in South Africa., where the central bank (SARB) continues to catch up with the rest of the emerging market pack. The SARB has made two major back-to-back hikes of 75 basis points, bringing the policy rate to 6.25%, and the medium-term fiscal projections just released – especially the smaller deficits – should ease the pressure to pursue aggressive increases. The main concern, as usual, is budget execution, as some revenue assumptions appear optimistic and expenditure reserves may not be sufficient, given the global economic and political uncertainties. Still, the market hit the top five figures, with the 10-year yield narrowing 13 basis points and the South African rand trading 92 basis points against the US dollar (as of 10:00 a.m. ET, according to Bloomberg LP).
Tax reform in Colombia
Tax discussions are all the rage in LATAM, where the Colombian congress is expected to approve the new tax bill in the coming days. What is at stake here is not only the pace of fiscal adjustment, but also the impact of tax reform on the oil sector, which accounts for a large share of the country’s export earnings and foreign direct investment. Colombia. The approval process – and the market’s reaction to it – will also determine the central bank’s ability to slow the pace of rate hikes. Colombian assets have been hit by recent political and political noise, with local debt (JP Morgan’s GBI-EM Colombia Index) posting the third worst total return (or rather total loss) since the start of the year (see chart below). below). Stay tuned!
Chart at a Glance: Emerging Markets Local Debt – YTD
Source: Bloomberg LP.
Originally published by VanEck on October 26, 2022.
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PMI – Purchasing Managers Index: economic indicators drawn from monthly surveys of private sector enterprises. 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 more than 400 surveys of purchasing and supply managers; in both manufacturing and non-manufacturing industries; CPI Consumer Price Index: an index of the change in prices paid by typical consumers for retail goods and other items; PPI – Producer Price Index: a family of indices that measures the average change in selling prices received by domestic producers of goods and services over time; PCE inflation – Personal consumption expenditure price index: a measure of US inflation, tracking changes in the prices of goods and services purchased by consumers across the economy; MSCI-Morgan Stanley Capital International: a US provider of equities, fixed income, hedge fund stock indices and equity portfolio analysis tools; VIX – CBOE Volatility Index: an index created by the Chicago Board Options Exchange (CBOE), which shows market expectations for 30-day volatility. It is constructed using implied volatilities on 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 Markets Bond Index: JP Morgan index of sovereign bonds denominated in dollars issued by a selection of emerging countries; EMBIG – JP Morgan Emerging Markets Global Bond Index: tracks the total returns of external debt instruments traded in emerging markets.
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