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23 Apr 2015
What happens to EM after Fed’s hike? – BAML
FXStreet (Barcelona) - US data is expected to improve after the Q1 debacle and Fed lift-off will be back on track, explain Strategist at BofA-Merrill Lynch, and further share the potential impact on rates in emerging markets after the Fed hike begins.
Key Quotes
“Weak 1Q growth and a perceived dovish Fed bias have left Fed Funds futures only pricing one hike for this year and less than three hikes in 2016. This compares to about four hikes priced in early March and an implied 4-5 hikes according to the dot plots.”
“Our US team expects the data to improve after the 1Q weakness, which should bring the Fed lift off back into focus.”
“If there is a turnaround in the market’s Fed expectations, economies with tight linkages to the US, above-target inflation, higher pass-through risks or external vulnerabilities could experience greater upward pressure on the front end of their local yield curves.”
“LatAm is the most highly linked region to the US; as a result, front-end rates there would likely rise more than Asia and EEMEA on average. Although in our base case Chile’s central bank will remain on hold, BCCh could face pressure to hike policy rates in the near term.”
“In Mexico, our base case is for Banxico to begin hiking in 4Q, after the Fed.”
“In South Africa, we are already penciling in the start of the hiking cycle in 4Q, followed by 100bp of hikes in 2016.”
“We expect Turkey to face the sharpest turnaround in policy upon the start of the Fed hiking cycle and we forecast policy rates to hit 9% in 1Q next year.”
“We also examine how sensitivity to US rates has changed recently by regressing 1y EM rates on 1y US and EU swaps, the monthly year-over-year inflation, a dummy that takes a value of 1 for 2015, and the interaction of this dummy with the US 10y swap rate for data from 2010-15. We find that front-end sensitivity to US rates has increased in 2015 relative to 2010-14 in Turkey, Chile, India, Singapore and Mexico.”
Key Quotes
“Weak 1Q growth and a perceived dovish Fed bias have left Fed Funds futures only pricing one hike for this year and less than three hikes in 2016. This compares to about four hikes priced in early March and an implied 4-5 hikes according to the dot plots.”
“Our US team expects the data to improve after the 1Q weakness, which should bring the Fed lift off back into focus.”
“If there is a turnaround in the market’s Fed expectations, economies with tight linkages to the US, above-target inflation, higher pass-through risks or external vulnerabilities could experience greater upward pressure on the front end of their local yield curves.”
“LatAm is the most highly linked region to the US; as a result, front-end rates there would likely rise more than Asia and EEMEA on average. Although in our base case Chile’s central bank will remain on hold, BCCh could face pressure to hike policy rates in the near term.”
“In Mexico, our base case is for Banxico to begin hiking in 4Q, after the Fed.”
“In South Africa, we are already penciling in the start of the hiking cycle in 4Q, followed by 100bp of hikes in 2016.”
“We expect Turkey to face the sharpest turnaround in policy upon the start of the Fed hiking cycle and we forecast policy rates to hit 9% in 1Q next year.”
“We also examine how sensitivity to US rates has changed recently by regressing 1y EM rates on 1y US and EU swaps, the monthly year-over-year inflation, a dummy that takes a value of 1 for 2015, and the interaction of this dummy with the US 10y swap rate for data from 2010-15. We find that front-end sensitivity to US rates has increased in 2015 relative to 2010-14 in Turkey, Chile, India, Singapore and Mexico.”