I imagine this is going to go by the wayside amid the Italian turmoil and renewed trade banter between Trump and China, but it’s worth noting, so I’ll touch on it briefly here.
Over the past several weeks, emerging market monetary authorities have been at pains to shore up confidence in the face of the surging dollar, rising U.S. yields and a Fed that looks determined to stick to its guns on rate hikes.
Yes, 10Y yields in the U.S. fell by the most since Brexit on Tuesday as traders flocked to havens and yes, renewed euro breakup risk has forced a repricing of the Fed, but all of that is a recent phenomenon and the overall backdrop for EM remains challenging.
The recent turbulence in EM has so far prompted a pause on rate cuts from Brazil, triggered the first rate hike since 2014 from Bank Indonesia, prompted multiple dramatic rate hikes from Argentina’s central bank and even forced Erdogan to acquiesce to an emergency rate hike to put the brakes on the Turkish lira’s collapse (that hike was followed by an important announcement from CBT on the future of monetary policy in Turkey).
Well on Wednesday, Bank Indonesia hiked again at an early policy meeting, proving new Governor Perry Warjiyo is pretty serious about staying ahead of the game.
This was expected, but its significance shouldn’t be completely downplayed or otherwise lost in the shuffle. The rupiah sank to a 29-month low earlier this month and bond yields have been on the rise, as Indonesia is coping with the same external shocks from tighter Fed policy as the broader EM complex. I’m not going to look too far into this, but a quick glance at my go-to chart suggests things have stabilized a bit over the past week following the May 17 hike:
Indonesia equities have likewise rebounded from near 11-month lows:
The problem for BI is that they’re a bit hamstrung by worries about the extent to which tightening policy will hurt consumers.
“Bank Indonesia faces a dilemma in the months ahead [as] too aggressive a pace of tightening will hurt the economy and is not warranted given the benign inflation outlook (BI and we see end-2018 inflation at 3.6%, in the middle of the target range)” BofAML wrote after today’s hike. “At the same time, BI will not want to fall too far behind the US Fed’s normalization path and much will depend on IDR movements.”
“Bank Indonesia’s determination to stabilize its financial markets and its decision to raise rates at an out-of-cycle meeting provides a certain level of support, but the rupiah will probably remain as one of the more vulnerable currencies in Asia,” Nomura’s Kenta Tadaide told Bloomberg in a phone interview on Wednesday, adding that while there’s “some room for Indonesia to allow for a gradual currency weakness to support their exports when sentiment stabilizes, when the currency is sold in a risk-off environment and if they don’t do anything, [the] selloff deepens, [it] forces them to do something about it now”.
Yes, they had to do something about it “now”. And see, that’s why this is notable.
This is all about getting out ahead of (or at least keeping pace with) the Fed. This is the same dilemma facing all emerging markets right now. Idiosyncrasies and country-specific risks are an issue, but as detailed here over the weekend in “Shaking The Tree: The Fed, ‘Overripe Fruit’ And A Half-Full Snifter“, everyone seems to understand that Jerome Powell likely overstated the case when, at an IMF/SNB event earlier this month, he said the following about EM in the context of the Fed:
Monetary stimulus by the Fed and other advanced economies played a relatively limited role in the surge of capital flows to (emerging market economies) in recent years.
There is good reason to think that the normalization of monetary policy in advanced economies should continue to prove manageable for EMEs. Markets should not be surprised by our actions if the economy evolves in line with expectations.
Today’s out-of-cycle hike by BI implicitly suggests Powell’s assessment is not entirely realistic.
Is the reason a 10Y’s yield falls during high demands for safe havens is because supply and demand dictates you have to pay more to get it, which in turn makes it cost more, and as a result that higher cost causes the end yield to be less?