Struggling emerging markets face new pain from us Rate hike


By Reuters IST (Released)

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Many past emerging market crises were linked to the strength of the dollar and rising US interest rates, forcing developing countries to adopt tighter monetary policy to shore up their own currencies and fight inflationary pressures. which drove up the cost of servicing dollar-denominated debt.

The prospect of US interest rates climbing to all-time highs on the eve of the global financial crisis has cast a new pall on emerging economies that have struggled to recover from COVID-19, battling inflation galloping and a flight of capital.

Many past emerging market crises were linked to the strength of the dollar and rising US interest rates, forcing developing countries to adopt tighter monetary policy to shore up their own currencies and fight inflationary pressures. which drove up the cost of servicing dollar-denominated debt.

This time around, there are some differences: Emerging central banks have been leaders rather than laggards in the tightening cycle, with policymakers in many regions initiating rate hikes as early as summer 2021.

Yet, with major central banks now joining the battle against inflation, markets are forecasting the US Federal Reserve to raise interest rates to 4.6% by March 2023, a move that will push inflation higher. pressure, especially in smaller and riskier developing economies.

That’s a sharp and rapid change from just 12 months ago, when Fed forecasters predicted no rate hikes in 2023.

“This year has been a perfect storm,” said Damien Buchet, CIO at Finisterre Capital, adding, “The Fed and European Central Bank (ECB) are behind the curve we need to move towards tighter conditions. financial”.

Some of the world’s poorest countries expect debt service payments to reach $69 billion by 2024 – the highest level in the current decade, according to a recent report.

It’s been a tough year for financial markets as countries grapple with a potential recession and energy shock following the war in Ukraine, but some emerging market assets have been disproportionately affected.

Equities in developing countries have fallen around 28% this year, underperforming major developed benchmarks in Europe and the United States, which have fallen around 20%. Yields on hard-currency and local-currency fixed-income securities are deep in the red, while currencies – with a few exceptions, mainly in Latin America – have also fallen.

capital flight

Emerging market assets suffered a bout of record outflows triggered by Russia’s February 24 invasion of Ukraine, according to the Institute of International Finance’s capital flow tracking institute. Capital outflows from emerging markets outside China, which only ended in August, were similar to those of the 2013 crisis, the IIF said in September.

“The fortunes of emerging markets continue to rest quite heavily on what the Fed does,” said Manik Narain, head of emerging markets strategy at UBS.

Major emerging market central banks had hiked rates nearly 6,000 basis points in 2022 through the end of August in their fight against inflation, according to Reuters calculations.

But tighter monetary policy is also holding back economic growth. The Fed’s actions, along with those of other major central banks, have sparked early warnings from international officials and analysts that rising rates of currencies such as the dollar and euro could tighten financial conditions. world to the point of leading to a global recession.

Developing central banks are at different stages of the tightening cycle, said Claudia Calich, head of emerging market debt at M&G Investments.

“If you look at the futures and implied curves of some Latin American countries like Chile and Brazil, those markets are really starting to drop in price rates for the second half of next year,” Calich said. at Reuters.

Central and Eastern European central banks still need to make a few more rate hikes, although the cycle is also coming to an end, Calich added.

Almost finished and dusted

Overall, many of the largest emerging market economies benefited from better fundamentals, such as Brazil, Mexico or South Africa, which raised rates, built up reserves and benefited from healthy trade balances thanks to a surge in commodity prices.

Deeper liquid markets in major emerging economies allowed them to focus on local debt. However, there is little respite on the charts for smaller and riskier emerging markets.

A record 14 of these so-called frontier markets that have issued international debt are seeing their bonds trading at a premium of more than 1,000 basis points to safe-haven US Treasuries. Many others like Egypt or Kenya are a hair’s breadth from these levels.

These wide spreads in bond yields mean that these countries are effectively shut out of the markets and unable to refinance themselves at this stage. Many, like Egypt and Ghana, have knocked on the door of the International Monetary Fund (IMF) to help shore up their funding.

Raphael Kassin, head of emerging market hard currency debt at Itau Asset Management, said investors needed clarity on how long rates would stay high.

“If it’s temporary, it’s fine. The majority of countries don’t have big financial needs this year or next year. What really matters is what happens in the longer term.”


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