EMLD World Tour Sept 2021: Chile’s surprise rate rise

Invesco’s Global Debt Team publishes monthly emerging market local debt (EMLD) outlooks and a spotlight on a new country each month and below is their update for September. The team are based in New York and are part of the Invesco Fixed Income Investment Centre, known as IFI. To learn more about Invesco’s Global Debt Team, click on the link for your local website below.

Chile’s higher than expected interest rate hike in August suggests the central bank is moving towards a faster normalization policy and is tightening much more quickly than previously thought. 

The Central Bank of Chile ended August on a hawkish note wanting to avoid inflation spinning out of control. Before the policy meeting, the market was split in expecting either the continuation of gradual policy normalization (25 basis point rate increase), or a slightly faster pace (50 basis points).

Given recent strong economic data and higher than expected inflation, our team was in the latter camp and expected the pace of normalization to accelerate. In the end, the Central Bank of Chile surprised the market with a hike of 75 basis points, taking overnight rates to 1.5% from 0.75% on the 31^st August.

The central bank now expects policy to move from accommodative to neutral by mid-2022. We believe the risks to this projection are to the upside and there may be a need to move toward restricting growth.

The government’s potential approval of a fourth round of early pension withdrawals and additional cash transfers related to the pandemic could push growth and inflation higher in the coming months, but these are not included in the bank’s base case.

We remain cautious on Chilean interest rates. We are neutral on the currency as well due to political risks, with both a presidential election and constitutional reform on the horizon.

What next in emerging market debt?

We believe solid global growth and benign financial conditions are supportive of emerging market local debt. We are focused on emerging market fundamentals (the Delta variant will likely not prevent country re-openings) and the divergence among central bank’s monetary policies.

Some are being forced to react to inflationary pressures (Brazil, Chile, Russia), some are hiking gradually (Mexico, Hungary, Czech, Peru), some are likely to begin hiking in the next few months (Colombia, Poland and possibly South Africa), and some are unlikely to hike (Indonesia, Thailand, India).

In emerging market interest rates, we have become more cautious on Brazil and continue to find value in Russia and Indonesia. 

We also remain cautious on the Central and Eastern European (CEE) countries but think Mexican short-term, South African long-term, and Russian medium-term interest rates are attractive. In currencies, we favor the Thai baht, Polish zloty and South Korean won. In terms of regions, we have become less cautious on Asia and favor euro-like emerging market currencies, especially the Polish zloty.

It is interesting to note that the average key policy rate of 20 emerging market central banks has risen from a low of 2.65% one year ago to 3.5% today (Figure 1). 

In contrast, no rate hikes have materialized in developed market countries during the same period, with most large developed markets only talking about announcing tapering, let alone hiking rates.

We expect, in emerging markets, the average policy rate to increase in the next few quarters, though gradually, as the early hikers are nearing the end of their current cycles and the number of new hikers should be limited.