EM Weekly
A Qualitative and Quantitative
Emerging Markets Review
October 2, 2021

Debt ceiling brinkmanship in the U.S. Congress amid rising UST yields (with UST10y yields briefly breaking back above the psychological 1.50% level), USD strength, and spiking energy prices globally dominated most of the last week of the third quarter. Overall, this was not a good mix for equities that slid throughout the week, pushing VIX higher in the process (to the 23-24 range, from 18 at the start of the week. The first day of October saw some selective measured optimism returning to risk markets after the S&P500 recorded in September its worst month since March 2020 and EM suffered highest outflows from the asset class since March 2021. The U.S. Congress managed to pass a stopgap funding bill on Thursday afternoon that avoided a federal government shutdown this Friday, but U.S. debt ceiling noise is likely to continue well into 4Q. Gas prices in Europe surged to a record before retreating somewhat as headlines hit that the Chinese authorities have directed state energy companies to secure energy supplies for the winter “at any cost”, stoking fears of a short term demand squeeze that could push prices even higher. Meanwhile, the leaders of the G4 systemic global Central Banks, Andrew Bailey (BOE), Haruhiko Kuroda (BOJ), Christine Lagarde (ECB) and Jerome Powell (Fed) participated together in an ECB virtual panel event, but without providing any new information to markets beyond the well telegraphed “taper is separate from liftoff” line from the Fed. Earlier in the week, Fed Chair Powell and Treasury Secretary Janet Yellen testified in front of the Senate Banking Committee, warning that a U.S. default due to a failure to raise the debt ceiling would have very material consequences for the economy and markets. Comments by senators during the hearing raised question marks around the odds of Powell’s reappointment, although it remains the base case for now. Overall, the Chair’s comments sounded marginally more dovish this week in comparison to last week’s FOMC and press conference, as Powell stated that the U.S. is a “long way” from meeting the maximum employment test, but that the Fed has “all but met” tests to taper, highlighting once more the taper vs liftoff distinction. In terms of notable data releases, the PCE index, the Fed’s favorite inflation measure, went up to 4.3% in August, from 4.2% in July, while robust Personal Spending (0.8% y/y in August, from 0.3% in July) signaled resiliency on the U.S. economy’s demand side. Chinese non-manufacturing PMIs rebounded strongly in September (53.2 vs 49.8 consensus estimate and 47.5 in August) after last month’s significant miss, indicating that the weakness in the service sector was likely limited to the period of temporary restrictive measures introduced in August to combat the spread of the Delta variant. In China, PBOC released a statement this week assuring the public that the intention of the authorities is to ensure a “healthy” real estate market. In this context, although uncertainty around the Evergrande situation remains high, signals are getting stronger that the government is unlikely to allow it to become a systemic crisis. Last but not least, the USD was in focus this week, having reached its highest level against other major currencies since November 2020. EMFX, not surprisingly, was the mirror image of dollar strength, dropping to the lowest level over the same time period. The USD has staged similar rallies at the end of the previous two quarters this year, so there might be a decent technical aspect to the current dollar strength. However, we also note the challenging macro backdrop for a number of EM currencies due to sticky elevated domestic inflation dynamics eroding real rate buffers and increasing vulnerability to episodes of USD strength.