Insight

EM central banks stay on rate cutting path, with eyes on the Fed

EM central banks stay on rate cutting path, with eyes on the Fed

Overview

  • The EM local debt asset class is in good shape, in our view, thanks to solid macro fundamentals, attractive valuations and favorable interest rate differentials versus developed markets.
  • EM central banks have continued to lower interest rates but are carefully watching Fed moves for their future policy direction.
  • After South Africa’s recent election, we expect general macroeconomic stability and see potential opportunities in South African assets.
  • Sizeable capital inflows continue to help improve Egypt’s financing conditions. Adherence to a recently expanded IMF program should help stabilize the country’s economy and promote external confidence and investment flows.

Market commentary

Emerging market (EM) central banks lowered interest rates over the past month, but with a more cautious approach, as expectations for US monetary policy softened. In Latin America, Peru proceeded with another 25 basis point rate cut, while indicating possible further reductions in its policy rate below the Fed’s rate. Chile and Brazil reduced the pace of their cuts to 50 basis points and 25 basis points, respectively. The Czech Republic and Hungary each cut rates by 50 basis points, maintaining their current pace of rate reductions, but suggesting that the next cuts might be smaller.

South African election

In South Africa, the African National Congress (ANC) secured a majority of seats in Parliament, but fell short of expectations, causing speculation about the formation of a coalition government. Pre-election polls had suggested the ANC would secure close to 45% of the vote, paving the way for a coalition government and allowing President Ramaphosa to push forward with his reform plans. However, the ANC managed to secure only 40% of the vote, surprising market participants. We expect this outcome to cause volatility in South African asset prices over the next few weeks, but we expect the ANC to eventually form a government and Ramaphosa should proceed with his reform agenda. We expect policy to remain stable going forward and currently see potential investment opportunities in South Africa.

Fed policy

We believe we are slowly approaching the beginning of the US Federal Reserve (Fed) cutting cycle. US second quarter growth was in line with or below expectations, and revisions have come in consistently lower. These factors, along with an ongoing disinflation process, provide us with cautious confidence that EM central banks will likely shift their focus to domestic cycles after dealing with external shocks in the early part of the year. As we enter this phase of the cycle, we expect rates markets to display greater differentiation based on domestic policies, compared to currency markets, which will likely be more influenced by US dollar strength or weakness.

Overall, we believe the EM local debt asset class is in very good shape. Attractive carry, healthy economic growth, and favorable interest rate differentials versus developed markets present a favorable outlook for EM local debt performance in the second half of the year, in our view. Additionally, we believe the unique local narratives within EM contribute to a diverse and lucrative opportunity set. 

Investment risks

The value of investments and any income will fluctuate (this may partly be the result of exchange rate fluctuations) and investors may not get back the full amount invested. 

Fixed-income investments are subject to credit risk of the issuer and the effects of changing interest rates. Interest rate risk refers to the risk that bond prices generally fall as interest rates rise and vice versa. An issuer may be unable to meet interest and/or principal payments, thereby causing its instruments to decrease in value and lowering the issuer’s credit rating. 

The risks of investing in securities of foreign issuers, including emerging market issuers, can include fluctuations in foreign currencies, political and economic instability, and foreign taxation issues. 

The performance of an investment concentrated in issuers of a certain region or country is expected to be closely tied to conditions within that region and to be more volatile than more geographically diversified investments.

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