Higher Fed terminal rate, Implications for emerging markets – Standard Chartered

Market pricing of a higher Fed terminal rate seems to reflect more inflation concerns than a growth boost. Inflation-driven Fed tightness is more detrimental for EM economies. Our resilience index shows Mexico, Saudi Arabia and India are comfortably in the safe category. Egypt, Pakistan and Bangladesh are less resilient, Standard Chartered’s economist Madhur Jha notes.

Gauging resilience to elevated Fed rates

“The Fed has started its easing cycle, yet markets are factoring in a higher Fed terminal rate in the medium term. Pricing of a higher Fed terminal rate seems to be largely driven by expectations of higher inflation, but might also be increasingly capturing forecasts of stronger US growth. What is driving the terminal rate higher matters for the rest of the world. Historically, EM countries have fared worse when the Fed tightens policy in response to inflation concerns as there is no offset from stronger US demand.”

“We try to gauge which EM economies are better able to withstand tighter global liquidity conditions medium-term. We focus on indicators that are more macro, such as growth and inflation prospects, but also take into account fiscal space indicators, proxies for policy credibility and external-sector health, which would make an economy particularly vulnerable to less favourable global liquidity conditions.”

“Latam countries, led by Mexico, dominate the list of most resilient economies. Saudi Arabia’s reforms, which are likely to boost growth, and its healthy external debt position place it in a favourable position. And India’s policy credibility, focus on capex and healthy external debt position also place it in the more resilient category. Countries that have IMF programmes like Pakistan and Egypt fall into the most vulnerable category, though many of them are now turning the corner, having been through recent periods of crises.”