For Some Emerging Markets, It’s Time To Cut While The Cuttin’s Good

Global equities were on shaky footing Thursday as market participants fret over what looks like a stalemate in the US-China trade war, earnings and an uncertain economic environment.

In a sign of the times, both South Korea and Indonesia cut rates. Neither of the moves was a “surprise”, per se, although the BOK’s decision to pull the trigger now (as opposed to later) wasn’t the base case headed into Thursday.

Remember, South Korea has struggled mightily in the face of the trade war. Jitters about a turning of the semi cycle and, more recently, a bitter spat with Japan, have made things much worse. The BOK slashed its economic forecasts Thursday as well. It now sees the domestic economy growing 2.2% this year, from the 2.5% rate seen in April. Inflation is expected to rise 0.7%, compared to 1.1% previously.

The BOK cut comes on the heels of November’s hike, delivered when the Fed still seemed likely to press ahead with tighter policy and EMs were keen on averting any more problems like those that defined summer 2018.

Rates are now only 25bps from a record low, which could constrain policy. But the market clearly expects more easing and a continuation of the challenging macro environment. 3-year yields have plunged to ~1.35% from 1.84% in March.

For their part, Bank Indonesia was notoriously aggressive in staying out ahead of things last year, raising rates 175bps amid the Fed-inspired EM mini-crisis. That likely affords BI considerable room to cut further going forward as DM monetary policy shifts dovish.

This was the first cut from Indonesia in nearly two years and some see multiple cuts by the end of 2019. Still, Indonesia will need to be cautious to avoid rattling foreign investors. Fed cuts will do wonders to help the situation and if the bank’s actions over the past 12 months (including the patient approach adopted in 2019) are any indication, you can expect policy prudence even amid the easing bias. Headline inflation is under control in the country, although core is rising.

“With this interest rate cut, all of Bank Indonesia’s policies are indeed aimed at maintaining economic growth momentum”, governor Warjiyo said Thursday, citing the trade war as one factor that keeps downside risks in focus.

All in all, this is just a reflection of EMs jumping at the opportunity to mitigate an increasingly worrisome macro environment. Jerome Powell, by essentially pre-committing to cuts, has opened the door for EMs to loosen.

It’s a welcome opportunity considering this is the same Powell who, in May 2018, somewhat naively claimed that “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”. He went on to suggest that “the normalization of monetary policies in advanced economies should continue to prove manageable for emerging markets”.

Those were famous last words. Presumably, he knows better now.


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