As widely expected, the FOMC left interest rates unchanged on Wednesday, but maintained a hawkish tone and moved the median dots projections for the end of 2024 and 2025 50bps higher. Predictably, UST yields and the Dollar moved higher, placing riskier assets, including EM, under pressure. The fact that the Bank of England (BoE) and Swiss National Bank (SNB) defied expectations and paused their respective tightening cycles did not help much in the context of the Fed’s “higher for longer” signaling and duration remained under pressure. The BoJ also remained on hold, while Norges Bank and Riksbank both lifted rates by 25bps. Meanwhile, final Euro Area CPI for August was confirmed a touch lower than expected, fueling hopes that it could cool down further to below 5% in September, which could help markets regain some optimism that rates in Europe might have peaked. Oil prices remained well supported amid supply concerns, with Brent crude marking a new ten-month high close to 95 USD per barrel. In EM, the Central Bank of Brazil (BCB) cut the benchmark SELIC rate by 50bps to 12.75% and signaled that the easing cycle is likely to continue at the same pace in the coming months. Turkey’s economic team held meetings with international investors in New York and London to reassure them that the ongoing shift in economic management under the leadership of MinFin Mehmet Simsek is sustainable and has President Erdogan’s full support. To reinforce the message, the Central Bank delivered a second consecutive 500bps rate hike to 30% as part of normalizing monetary policy and guided that more tightening measures are coming. Egypt and South Africa kept rates unchanged as the authorities are looking toward elections in the former and fiscal tightening in the latter. Pakistan also announced a date for national elections in January 2024, alleviating near-term political uncertainty, and committed to meeting outstanding targets under its IMF program to unlock much needed fresh external financing.

This week’s 500bps hike, in addition to the clear signals that more policy tightening is in the pipeline supports the view that the ongoing gradual but major shift in economic management under Minister of Finance Simsek, has President Erdogan’s blessing and is likely to continue in the coming months. We expect the CBT’s main policy rate to end the year at 35% after another 500bps of tightening in 4Q and to reach 40% by the first quarter of next year. We believe that risks are on the upside of our base case given that elevated sticky inflation (projected at around 65% YoY at year-end 2023) and the recent spike in global energy prices might require even more forceful tightening by the authorities to restore confidence in Turkey’s inflation targeting regime. As Minister Simsek declared in meetings with investors in New York this week, attaining price stability is his team’s main priority in the near-term. In that context, we expect further monetary policy tightening to be complemented by regulatory measures to slow credit growth as well as quantitative tightening measures such as higher reserve ratio requirements for bank FX and FX-protected deposits, among others. Additional priorities include rebalancing GDP growth toward exports rather than domestic demand and rebuilding FX reserves buffers. All of this marks a material market-friendly departure away from the economic heterodoxy of the recent past, which is credit positive, and we believe has President Erdogan’s endorsement. However, we caution that Minister Simsek’s ambitious macro stabilization program could face resurfacing political constraints if it drives significant deceleration in economic activity ahead of the important municipal elections in March 2024.

The monetary policy committee of the Brazilian Central Bank, the COPOM, cut its benchmark SELIC rate by 50bps to 12.75% in a unanimous decision for the second straight time and signaled a similar pace of policy easing in 4Q. Having been on the forefront of the monetary response to the post-pandemic inflationary spiral, the BCB is now leading EM in unwinding the policy tightening. Given inflation levels of around 5% and high real interest rates, the authorities have ample space to support economic activity with gradually lowering rates further in the coming months. As such, we expect the COPOM to retain the 50bps rate-cutting pace at the last two meetings for the year and bring the policy rate to 11.75% by year end. Meanwhile, recent data showed that the economy performed better than expected in the first half of this year, supported by a record high harvest, demand for services and a strong labor market. However, the BCB expects that activity will likely slow in coming quarters. This, in combination with headline inflation projected by the authorities at around 3.5% YoY and medium-term inflation expectations being re-anchored, should allow monetary policy easing in Brazil to continue apace in 2024, creating a “goldilocks” environment for local assets, in our view.

IIF warns countries will have to allocate more to interest expenses as debt as a share of GDP starts to rise again  The world economy’s debt pile hit a fresh high in the first half of this year, while borrowing as a share of gross domestic product is rising again after nearly two years of declines. Total debt — spanning sovereigns, corporates and households — rose by 10 trillion USD to about 307 trillion USD in the six months to June. The previous peak for global debt was in early 2022, before central banks started aggressively raising interest rates. Global debt as a share of GDP, which had been falling due to high inflation, rose to 336% by June this year, a 2-percentage point rise since the start of the year. But it remains below a peak of about 360% hit during the coronavirus pandemic. The rise in debt comes as higher interest rates in most countries push up borrowing costs — a crucial determinant of sovereign credit ratings. It also comes as financing the climate transition puts pressure on governments to boost spending. “Our concern is that countries will have to allocate more and more to interest expenses,” said Emre Tiftik, the lead author of the IIF’s report. “It will have long-term implications for countries’ funding costs and debt dynamics.” The IIF said that more than 80% of the additional debt in the first half of the year came from mature markets, with the US, Japan, UK and France registering the largest increases. “Rising interest bills are a key risk to public finances and sovereign ratings, particularly in developed markets,” said Edward Parker, managing director at Fitch Ratings, the credit rating agency that downgraded the US earlier this year.  It warned that as more countries are forced to restructure their debt, the high level of domestic debt leaves them vulnerable because the IMF’s debt restructuring program is more geared towards external creditors such as investment funds and other sovereigns and foreign currency debt. Governments should take urgent steps to help reduce debt vulnerabilities and reverse long-term debt trends. Reducing debt burdens will create fiscal space and allow new investments, helping foster economic growth in coming years.