By Natalia Gurushina
Chief Economist, Emerging Markets Fixed Income
Is a deepening recession likely to ‘reverse’ emerging market local debt outperformers this year?
Emerging Markets Local Debt Performance
Rise in global inflation and elusive inflation spikes have not been supportive for local emerging market (EM) rates so far this year. But – as the graph below shows – currency dynamic can make a big difference for the total return of emerging market local debt. Central bank credibility and timely/aggressive policy response gave the South African Rand and LATAM FX a much-needed boost. The question is whether a growing risk of recession will change the rules of the game in the second half. Very low consumer confidence in parts of Europe, below-consensus business surveys in developed markets (DM) and the downward revision to first-quarter GDP in the US (particularly private consumption ) suggest that this risk could not be fully priced by the market.
Emerging Markets Growth Prospects
Regarding the outperformance of local debt in emerging markets since the beginning of the year, The 2022 growth outlook for LATAM has actually been slightly improved after hitting bottom in March-April. The tightening cycle in the region needs to continue – which means tight policy – as inflation is high and well above target. However, aggressive frontloading should be allowed to proceed at a slower pace (rate hikes) going forward, with the prospect of possible rate cuts later in 2023. South Africa’s growth news is more worrying yet. First, the central bank came late in the EM tightening cycle and may need to step up rate hikes to bring inflation back into the target range (headline inflation escaped last month). Today’s comments from Governor Lesetja Kganyago regarding a potential 50 basis point hike in July were deemed insufficiently hawkish by the market. Second, wage negotiations at the country’s electricity company, Eskom, have led to a new wave of load shedding and blackouts. Finally, consumer confidence fell sharply in the second quarter – to levels last seen in the early 1990s (with the exception of the pandemic).
Slowdown in China
The China’s next batch of indoor activity gauges – going out tonight – can be an important catalyst One way or another. The market reacted positively to changes in quarantine rulesand the consensus also expects the manufacturing and services PMIs (purchasing managers’ indices) to swing into expansion territory in June. China’s GDP forecast for 2022 was revised down again this morning (at 4.13%), but if the June PMIs do not disappoint, they may mark the low point of the current cycle. Stay tuned!
Chart at a Glance: Emerging Markets Local Debt Performance – Not a Monolith
Source: Bloomberg LP (JP Morgan GBI-EM Global Diversified Index)
Originally published by VanEck on June 29, 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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