Contents
Market Overview
Macro Review
The Federal Reserve cut interest rates by 25bps this week. But was it the right decision? Chair Powell argued that they were at a point where it would be appropriate to slow the pace of rate cuts. They have now cut interest rates by 100bps since September. However, the press statement was indecisive. The Summary of Economic Projections was easily troubling. For 2024 there were meaningful revisions to growth (higher), inflation (higher) and unemployment (lower). In fact, on the topic of Core PCE (the Fed’s preferred inflation gauge), three officials were concerned about upside risks to the 2025 forecast in September, but by December this had risen to 15 officials from a group of 19. The weighted forecast subsequently increased from 2.2% to 2.5%, which is a staggering move. Equally, the latest dot plot only includes 50bps of cuts in 2025, which is down from 100bps in September. Perhaps the Cleveland Fed President was correct in dissenting as the only FOMC member to vote against a rate cut. The ECB meeting was only six days prior and it was striking how President Lagarde and Chair Powell differ in their views and treatment of their respective economies. Understandably, the volatility in financial markets spiked. The 10-year U.S. Treasury rose above 4.50%, the DXY rose above 108 and the VIX rose to 27pts which we have not seen in months. Another risk factor that is brewing is a potential U.S. Government shutdown. Polymarket odds of a U.S. shutdown by year-end rose from 10% to 53% over the week. Far less focus was placed on the Bank of Japan that kept interest rates unchanged, but it did put JPY into a tailspin. The Bank of England also held rates unchanged but concerns of resurging inflation pushed the 30-year Gilt above 5.0%. The 10-year Gilt relative to the 10-year German Bund differential exceeded 230bps, which is higher than the Liz Truss “mini budget” debacle in October 2022. However, there was generally a muted reaction to weak European PMIs, and similarly to Moody’s downgrade of the French sovereign. The Canadian Dollar also hit its weakest intraday level in almost five years as its Finance Minister resigned and mounted significant pressure on Prime Minister Trudeau. Speaking of the need for a strong Finance Minister, Brazil was in focus. As of Thursday, Brazilian authorities had intervened in FX markets in the order of $14bn, but the intervention did little to curb the sell-off to an all-time low against USD. Brazilian assets remain in a precarious and fragile state as the MSCI Brazil languished 13% over the week. Brazil’s CDS rallied 46bps to 228bps, which is a 26% move over the week, with the sovereign USD bond curve widening 36bps as local government bonds tumbled. Brazil’s local bond curve saw yields rise 140bps over the week to the highest levels since 2016.
EM Credit Update
Emerging market sovereign credit (cash bonds) ended the week down 0.5% with credit spreads a mere 1bp tighter. Sovereign outperformers were Argentina, Ukraine and Iraq, while Brazil, Ethiopia and Gabon underperformed. With the exception of the FOMC meeting, other G10 risk events and Romanian politics, the market was mostly quiet into the holiday season. The reaction to China’s 5% growth target for 2025 along with a 4% budget deficit was equally muted, instead there were more question marks around the financial health of a state-owned property developer called Vanke.
The Week Ahead
Events next week are extremely limited given a series of public holidays.
Highlights from emerging markets discussed below: Market turmoil in Brazil detached from fundamental and economic realities, but reversal of sentiment requires commitment to politically unsavory spending cuts; El Salvador reaches staff-level agreement with the IMF; Romania’s rating outlook cut to negative on risk of delayed fiscal adjustment; and Senegal budget unveils wider deficit with moderate consolidation ahead.
Fixed Income
Equities
Commodities
Source for data tables: Bloomberg, JPMorgan, Gramercy. EM Fixed Income is represented by the following JPMorgan Indicies: EMBI Global, GBI-EM Global Diversified, CEMBI Broad Diversified and CEMBI Broad High Yield. DM Fixed Income is represented by the JPMorgan JULI Total Return Index and Domestic High Yield Index. Fixed Income, Equity and Commodity data is as of December 20, 2024 (mid-day).
Emerging Markets Weekly Highlights
Market turmoil in Brazil detached from fundamental and economic realities, but reversal of sentiment requires commitment to politically unsavory spending cuts
Event: Turmoil in Brazilian assets intensified this week as a 100bps rate hike, hawkish forward guidance, and repeated FX interventions by the Central Bank (BCB) failed to reverse bearish investor sentiment driven by concerns about medium-term fiscal sustainability. President Lula’s absence from the public eye due to his health problems has also contributed to the negative market mood, driving the BRL to its lowest ever nominal level vs the USD.
Gramercy Commentary: While medium-term fiscal concerns in Brazil are significant and need to be addressed, we note that the rest of the sovereign credit profile remains robust and stronger than most peers on many key metrics. As such, we are of the view that the sell-off, exacerbated by Lula’s health problems, has gone way too far relative to fundamental and economic reality. This being said, a reversal will likely require a commitment by the Lula Administration on potential additional fiscal adjustment measures for 2025 that go beyond what has already been included in a package that is in the final stages of approval in Congress. It remains unclear if President Lula will be willing to sacrifice political capital on such measures yet, but his willingness might increase as BRL weakness bites into his popularity and domestic economic sentiment. Meanwhile, the BCB, under a new Lula-appointed leadership team that will take over on January 1, has already hiked the SELIC policy rate by 100bps to 12.25% and guided toward two more hikes of the same magnitude in early 2025. As such, real interest rates in Brazil’s economy are headed back to the 10% mark, among the highest in global EM. If the market turmoil does not subside after the turn of the year, we think the BCB might be forced to step up further in order to stabilize the currency, while the market awaits more clarity on the fiscal outlook. An off-schedule rate hike or more aggressive FX interventions are among the tools that could be on the table.
El Salvador reaches staff-level agreement with the IMF
Event: El Salvador’s Government and the IMF reached a staff-level agreement on a new arrangement under the IMF’s Extended Fund Facility (EFF) for about US$1.4 billion. The agreement is subject to IMF Executive Board approval, which will likely come in 1Q 2025.
Gramercy Commentary: The staff-level agreement with the IMF in mid-December comes as the cherry on top of a spectacular 2024 for El Salvador’s sovereign bonds that delivered a 30%+ return to investors this year, among the highest globally in emerging markets. Given strong outperformance, we expect returns to moderate going forward, but we think the story will likely remain supported by the next market catalysts on the horizon: confirmation of the IMF deal by the IMF Executive Board in 1Q25, progress on reforms and further fiscal consolidation by President Bukele’s Administration under the program, and potential multiple notch credit rating upgrades next year. Meanwhile, on the long-standing controversial issue of Bitcoin’s status as legal tender in El Salvador, the IMF stated that risks are being mitigated. Acceptance of Bitcoin by the private sector will be voluntary (as opposed to mandatory) and public sector’s participation in Bitcoin-related activities will be confined.
Romania’s rating outlook cut to negative on risk of delayed fiscal adjustment
Event: This week, Fitch revised its outlook on Romania’s BBB- rating to negative and cited high political uncertainty which could delay fiscal consolidation as reason for the move. This follows annulment of the recent presidential 1st round election result due to foreign meddling as well as gains by far-right and right-leaning parties in the parliamentary vote, complicating the government formation process. Later in the week, initial talks were underway to form a coalition albeit absent clarity on a new presidential vote.
Gramercy Commentary: The overall political backdrop likely pushes out fiscal consolidation plans well into 2025 with additional negative outlooks possible. However, absent a sharper deterioration in financing conditions, we think agencies will hold off on rating downgrades, at least until there is greater political clarity. While not a base case in the current context, avoidance of upcoming pension hikes would be a near-term positive step on the fiscal side. A minority right-leaning coalition absent ruling PSD, but with its support, as it has indicated, would preserve stability and yield eventual fiscal adjustment, in our view.
Senegal budget unveils wider deficit with moderate consolidation ahead
Event: The Government presented its 2025 budget which detailed a larger than previously estimated 2024 deficit of 11.6% of GDP, but with plans to consolidate to 7.5% of GDP next year. While final information from the ongoing audit with respect to misreported loan data is still forthcoming, debt to GDP is estimated to rise by around 10% of GDP and lift debt service in the coming years. Authorities have stated their intent to smooth the upcoming maturity profile.
Gramercy Commentary: After a volatile 2024 amid a bumpy electoral process and negative fiscal surprises, we expect Senegal to begin a path of gradual normalization in 2025. We expect the Fund to ultimately provide a waiver on the heels of the concluded audit and fresh negotiations to begin over a new program in the spring. While an over 4% of GDP fiscal adjustment is comparably impressive, we think the Fund will push on the composition of the adjustment, particularly for gradual and targeted reduction of the 2% of GDP subsidy bill, which remains unchanged in the budget. We see the language regarding the intent to smooth debt service as a reflection of plans to conduct liability management rather than restructure. Notably, Senegal’s Eurobond maturities are modest and WAEMU membership combined with an improving current account should help to limit external risks.
Emerging Markets Technicals
Emerging Markets Flows
Source for graphs: Bloomberg, JPMorgan, Gramercy. As of December 20, 2024.
For questions, please contact:
Simon Quijano-Evans, Managing Director, Chief Strategist, [email protected]
Kathryn Exum, CFA ESG, Director, Co-Head of Sovereign Research, [email protected]
Petar Atanasov, Director, Co-Head of Sovereign Research, [email protected]
James Barry, Director, Deputy Portfolio Manager, [email protected]
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