Trump win seen to force emerging market rate rises

Posted on November 16, 2016

Mexico’s central bank is expected to have to raise interest rates by more than 100 basis points as a result of Donald Trump’s victory in the US presidential race, with Turkey and South Africa also likely to be forced to tighten monetary policy.

Elsewhere, Mr Trump’s election has erased expectations of rate cuts in China and Chile and slowed the likely path of monetary easing in Brazil.

However, market participants believe looser policy is now more likely than a week ago in India, where the chaotic aftermath of the government’s shock decision to demonetise 86 per cent of the currency in circulation is expected to lead to a slowing of economic growth.

“With [capital] flows to emerging markets turning negative and likely to remain negative for some time you should not expect EM central banks to cut rates any more, with a few exceptions. It’s [a case of] hiking or doing nothing,” said Maarten-Jan Bakkum, senior emerging markets strategist at NN Investment Partners, a Dutch investment house.

“This will probably stop the recovery in EM growth momentum. This is not an environment where flows to emerging markets can quickly recover.”

In Mexico, the market is now pricing in 165 basis points of monetary tightening over the next nine months, suggesting that Banxico, the central bank, will be forced to raise rates to either 6.25 per cent or 6.5 per cent, from their current level of 4.75 per cent, according to figures collated by Société Générale, the French bank. A week ago, market expectations were for just 47 basis points of tightening, in essence two quarter-point rises.

In Turkey, where policy rates have been held at 7.5 per cent since March, the market now sees an even more aggressive tightening cycle of 211bp by the central bank’s February 2017 meeting, up from 144bp before Mr Trump’s election.

In South Africa, where market participants had previously believed that the tightening cycle that has taken rates from a low of 5 per cent in 2014 to 7 per cent was over, about 42bp of further tightening is now expected in the coming 12 months.

While monetary tightening is not foreseen in Chile in the coming 12 months, easing is now also off the agenda. A week ago market participants were torn between expectations for either one or two quarter-point rate cuts by November 2017; now they see the benchmark remaining unchanged at 3.5 per cent.

In China, where traders were essentially pricing in a fall in the People’s Bank’s benchmark one-year lending rate from 4.35 per cent to 3.85 per cent over the coming 12 months, expectations are now for policy to remain on hold.

Changes to interest rate expectations, selected countries

Country Current policy rate (%) Forecast period Rate movement now priced in (bp) Change to forecast since Nov 8 (bp)
Mexico 4.75 9 months 165 118
Turkey 7.5 Feb 21 2017 211 67
South Africa 7 12 months 42 34
Chile 3.5 12 months -4 43
Brazil 14 Jul 26 2017 -206 37
China 4.35 12 months -1 45
India 6.25 Oct 3 2017 -45 -22
Source: Société Générale

Mr Trump’s victory has not been enough to extinguish expectations for sharp rate cuts in Brazil, where a fall in inflation from 10.7 per cent at the start of the year to 7.9 per cent in October has given the central bank room to build on last month’s quarter-point cut in the benchmark Selic rate to 14 per cent. However, expectations have been trimmed, with traders now expecting rates to fall to 12 per cent by next July, rather than 11.5 or 11.75 per cent.

Among the major emerging markets, only India has bucked the trend. The central bank is now expected to cut its repurchase rate by 50bp to 5.75 per cent in the next 12 months, twice the level of easing anticipated before the Modi government’s decision to withdraw 500 and 1,000 rupee notes from circulation, a move expected to crimp consumption in the short term.

Guy Stear, head of emerging markets strategy at SocGen, said India aside, central banks would be forced to act to support their currencies as higher Treasury yields in the US, driven by expectations of reflation, suck money out of emerging markets.

“The more pessimistic people are about currencies in the future the more the curve will reflect higher interest rates,” he said.

Mr Bakkum also saw a need for EM central banks to act to combat a rise in inflationary pressures emanating from weaker currencies.

“Because of higher energy and food prices in the first half of the year we have already seen inflation spike. Emerging markets have to be more careful about inflation than developed markets.”

Since last week’s US election, the Mexican peso has fallen 10.5 per cent against the dollar, the Turkish lira 5.1 per cent and the South African rand 8 per cent, with the rally in Treasury yields just one of the concerns of emerging market watchers.

“The knee-jerk reaction is fairly negative, simply because Trump’s policies are based on protectionism and isolationism,” said Mr Stear. “One of the growth pillars of many emerging markets is trade with the US and trade in general and EMs benefit from the US military umbrella. The US is keeping the peace in many areas. I think that’s particularly true in Asia.”

In September, Mr Bakkum lauded a “remarkable” improvement in emerging market growth, with NN IP’s proprietary EM Economic Growth Momentum Indicator, which aggregates eight growth indicators in 20 countries, at its highest level in the past two years.

However, given that the pick-up in growth was driven primarily by capital flows from developed to emerging markets, easing financial conditions in the latter, Mr Bakkum said he was no longer optimistic about the prospects for EMs.

“We have seen a complete change in financial conditions in emerging markets. Capital is already flowing out so local yields in EM have already moved up,” he said.

“[The impact of capital flows] was the reason to be more positive and that now falls away, so I can’t remain positive because the macro indicators are not looking so good and trade is already weak.

“We were overweight EM FX and local bonds and equities. We are now underweight all EM assets. This is one of the sharpest turnarounds from a single event [we have seen],” Mr Bakkum added.

He was particularly concerned about China, which has already been battling capital outflows this year as people try to spirit money out of the country to protect its value in dollar terms, given the steady fall of the renminbi against the greenback. The advent of a newly energised dollar could exacerbate this problem, he fears

“China risk has been in the background, but it is likely to come back to the forefront. The risk that China will have bigger capital outflows has gone up. We could go even more underweight EM if we see China sliding.”

Mr Stear agreed the People’s Bank of China was now “maybe a little more on the back foot in terms of having to protect the currency [rather than] having free rein to cut interest rates”.

Mr Bakkum also believed Mr Trump might find it easier to implement tariffs on imports from China, rather than Mexico, another country he threatened action against during his campaign.

“It might be easier for Trump to do something about Chinese trade rather than Mexican trade. With China, you can make a case that it’s unfair, [with] dumping and lack of access to the Chinese market, but US companies are benefiting from Nafta,” he said, referring to the North American Free Trade Agreement, which Mr Trump has threatened to renegotiate or even tear up.

Amid such protectionist rhetoric, Mr Bakkum said NN IP preferred countries that are not overly reliant on exports and where structural change and “better policy execution” are producing stronger growth, such as India, Indonesia, Colombia, Argentina and Vietnam, while underweighting Turkey, Brazil, Malaysia, South Africa, Russia, Egypt, the Philippines and China.

Mr Stear was more relaxed, arguing that the capital flows out of emerging markets would be less marked than at the end of 2015, because less money flowed in in the first place.

However Mr Bakkum concluded: “EM debt markets benefited so much from the search for yield. The idea that the Fed will hike only once, gradually — that has now gone, and in the background we have the trade risk and some geopolitical risk. Every open economy in the world should be worried about protectionism.”

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