To read the full report, please download the PDF above.
Positioning for US rate cuts across the EM complex
EHSAN KHOMAN
Head of Commodities, ESG and
Emerging Markets Research –
EMEA
DIFC Branch – Dubai
T:+971 (4)387 5033
E: ehsan.khoman@ae.mufg.jp
SOOJIN KIM
Research Analyst
DIFC Branch – Dubai
T: +44(4)387 5031
E: soojin.kim@uk.mufg.jp
LEE HARDMAN
Senior Currency Analyst
Global Markets Research
Global Markets Division for EMEA
T: +44(0)20 577 1968
E: lee.hardman@uk.mufg.jp
MUFG Bank, Ltd.
A member of MUFG, a global financial group
Macro focus
US Federal Reserve (Fed) Chair Powell’s remarks at the Jackson Hole symposium in August left no room for ambiguity on the direction for policy rates, with the Fed set to deliver the first non-recessionary interest rate cut on 18 September. As US rates decline, the lower cost of debt should positively impact EMs through three transmission channels. First, it should create a more robust economic landscape. Second, the Fed's move towards easing should empower EM central banks to revivify their own easing cycles. Third, lower interest costs are poised to enhance returns across EMs, thanks to the strong correlation between EM debt and equity markets. To position tactically for Fed rate cuts (and the corresponding growth slowdown), and given the expectation that EM investment grade (IG) should outperform high yield (HY), we screen for longs within IG and shorts within HY based on duration and spread sensitivity to lower rates and weaker growth. Saudi Arabia, the UAE and Poland are among the higher duration attractive longs, which we pair with Nigeria and South Africa shorts given low duration and spreads.
FX views
The Fed’s guidance that its easing cycle will soon begin has made markets position that a weak USD trend will increasingly play out and to the benefit of many EM currencies – not just those in EM Asia (that have been outperforming of late). Face value there is merits to not rely on this rationale on a standalone basis, especially if the Fed lowers its policy rate more modestly than what is currently being priced by investors. Put differently, while there may be lower confidence in the strong USD view, this does not mechanically signal that markets should position for EM FX to appreciate uniformly. Indeed, there are some missing requirements, in particular the Fed likely being on a modest rate cutting path, global growth being on a less secure footing, and elevated geopolitical and US election uncertainties ahead.
Week in review
The National Bank of Hungary (MNB) kept its policy rate at 6.75%, amid ongoing inflation concerns and a deteriorating growth outlook. The Bank of Israel (BoI) kept its policy rate unchanged at 4.50%, as economic and geopolitical pressures mount. Inflation in Poland rose for August mainly due to food prices with rates likely to remain on hold until mid-2025. Second quarter GDP in the Czech Republic rose on higher consumption and investment readings. Finally, Moody’s has upgraded Oman’s credit ratings outlook from “stable” to “positive”, rating maintained at Ba1, owing to “ongoing improvements in the government's debt metrics, supported by elevated oil prices and prudent fiscal management”.
Week ahead
This week, there will be rates meetings in Poland (MUFG and consensus: on hold at 5.75%) and Egypt (MUFG: -100bps to 26.75%; consensus: on hold). August inflation data will be released for Turkey (MUFG: 51.5% y/y; consensus: 51.8% y/y). We will have Q2 2024 GDP data will be released in South Africa (MUFG: 0.4% y/y; consensus: 0.3% y/y). Finally, we will have PMIs released across the EM EMEA region for August.
Forecasts at a glance
Growth across the EM universe is set to stabilise as domestic fundamentals offset external drags, with some rotation from the largest to smaller EMs. Inflation and interest rates are both “over the hump” – disinflation is progressing, and the decline in rates will continue and broaden in 2024.
Core indicators
The latest weekly IIF flow data signalled that EM securities witnessed USD0.7bn of inflows in the week ending 30 August – first inflows in six weeks. We reiterate that the relationship between EM currencies and Fed decisions are crucial – higher rates normally strengthens the US dollar, diminishing the appeal of EM currencies, which can lead to capital outflows and increased borrowing costs for EM.
