EMLD World Tour October 2021: Czech hikes

Invesco’s Global Debt Team publishes monthly emerging market local debt (EMLD) outlooks, with a spotlight on a new country each month. The series is introduced here, with a few words on the team. Below is the update for October.

Last month, we highlighted the accelerating pace of rate hikes by the Central Bank of Chile. This month, the Czech National Bank (CNB) followed suit and surprised markets by raising its policy rate by 75 basis points.[1] As with Chile, financial markets appeared to be pricing in a smaller hike – in the range of 25 to 50 basis points.[2]

The CNB has always been an orthodox central bank and the larger than expected hike was a signal that inflation is likely to be more persistent than originally forecast. We believe current oil and natural gas shortages ahead of the winter season could put upward pressure on inflation, leading the CNB to frontload its rate hiking cycle.

With this in mind, we believe the five-year part of the rate curve is interesting. We expect the curve to invert but are cautious on duration overall, as questions remain over where the terminal rate will ultimately end up.

Additionally, the CNB’s decision will likely have knock-on effects in the region, with other central banks (such as the national banks of Hungary, Poland and Romania) potentially compelled to be more aggressive in their policy normalisation going forward.

What’s next for emerging market debt?

With COVID-19 slowly fading and economic activity robust, price pressures and perhaps more importantly inflation expectations have become pressure points for rates markets globally.

The US Federal Reserve (Fed) has cleared a path for tapering and other developed market (DM) central banks are starting to indicate a gradual unwinding of the extraordinary monetary stimulus implemented over the last 18 months.

While the Fed’s communication on tapering was positive for the US dollar in the short-term, we believe the impact on equity valuations may halt or even reverse the strong flows into equities, primarily US and Chinese, that have benefited the US currency. However, to see US dollar weakness in the medium-term, there would need to be continued improvement in non-US growth combined with US growth in line with market expectations.

Over the next few months, monetary and fiscal developments in the US are likely to have an outsized impact on global markets, with excess savings potentially attracted to ‘safer’ risk assets.

In addition to inflation concerns, market participants turned their focus to China in September. The fallout from China’s crackdown on its over-levered real estate sector may lead to slower growth and could have broader implications for other emerging markets (EMs) in the region. Though partially government-enforced for environmental reasons, the effect of power shortages could be similar.

It remains to be seen whether either factor will impact supply chains or add to global inflation pressures.