Will Chile be the next "runner" in the emerging market interest rate hike relay?

According to the Zhitong Finance APP, since Brazil and Ukraine began their interest rate hike processes last year, investors have been betting that the next developing economy to follow suit will be Chile. Fund managers from Kinea Investimentos, Ace Capital, and Itau Asset Management are all betting that swap rates will rise, as Chile's inflation has proven to be unusually stubborn, while the country's economy shows signs of recovery.

However, this bet is not without suspense. Last week, economists surveyed by the Chilean central bank not only did not predict an increase in borrowing costs this year but also expected two rate cuts within the next 12 months. Therefore, when the central bank's minutes from last Wednesday's meeting warned that inflation would persist and policymakers expressed a willingness to take all necessary measures to bring price increases down to target levels, fund managers must have breathed a sigh of relief.

Rodrigo Gaze, founding partner and portfolio manager at Ace Capital, stated, "Inflation is more stubborn than the central bank predicts, and the recent hawkish minutes indicate that policymakers may even raise rates before the September meeting."

These minutes caused the two-year swap rate to rise by 16.75 basis points on Wednesday, reaching its highest level in nine months, marking the largest increase since March of last year.

Brazil was one of the first developing countries to start raising borrowing costs last year, with policymakers having raised rates by a cumulative 275 basis points since September. Nigeria and Ukraine have also raised rates to curb soaring inflation.

Who's Next?

Earlier this month, Ace Capital wrote in an investor report, "We believe Chile will be the next emerging market to restart its rate hike cycle."

In late January, policymakers led by Rosanna Costa unanimously voted to keep borrowing costs at 5%, marking the first pause in rate hikes since July of last year, due to the depreciation of the peso and rising electricity prices hindering inflation's return to the 3% target level. A week later, statistical agencies reported that consumer prices surged 1.1% in January, the fastest growth in nearly two years, with the annual inflation rate accelerating to 4.9%.

Nevertheless, the subsequently released minutes were more hawkish than many had expected. Policymakers wrote, "The central bank will take appropriate and stringent measures, meaning that if necessary, the central bank is willing to change the direction of monetary policy and raise rates." At the same time, they expect inflation to be around 5% in the first half of this year.

Currently, swap rates reflect an expected increase of 23 basis points within the next 12 months. Since the beginning of the year, Chile's one-year swap rate has risen by more than 25 basis points.

According to Bank of America, algorithmic traders adept at capturing trends have also been very active in trading Chile's interest rate curve. Strategists at the bank, including Cristian Gonzalez Rojas, wrote in a report last week that commodity trading advisors (CTAs) are likely betting on rising swap rates in the middle of the Chilean interest rate curve.

Rate Hike Expectations

Can the Chilean interest rate curve reflect a 75 basis point hike? Gordian Kamen, head of emerging market sovereign strategy at Standard Chartered, stated, "Of course it can. But can the increase exceed this level? I have my doubts." "I think it's unlikely unless economic data worsens."

Marco Galardo, fixed income deputy manager at BICE Inversiones, stated that the divergence among Chilean economists and traders stems from differing views on inflation trends in the coming months. Galardo said, "The market seems to believe that inflation may persist for a longer time."

However, despite economists predicting rate cuts, their forecasts could also trigger a rise in borrowing costs. Gazza from Ace Capital noted that if the two-year inflation expectations rise to 3.1% in economists' surveys, exceeding the target rate for the first time since February 2023, policymakers may raise rates earlier.

Gazza reminded that we should not forget that the Chilean central bank is very "proactive."

In the latest central bank survey released last Friday, traders raised their forecast for the key rate in 12 months from 4.75% to 5%. Additionally, the proportion of traders predicting a rate hike in April changed from none to 7.7%. Now, 16.9% of traders expect a rate hike in June, while only 1.7% made such predictions before the January decision.

External Influences

The Federal Reserve will also play a role. As analysts readjust their expectations for U.S. rate cuts this year, and with President Donald Trump raising trade barriers, the pressure on the peso is increasing, making Chile's rate hikes more attractive.

Last Friday, weak U.S. retail sales data caused Chilean swap rates to fall from recent highs. This data led to a significant drop in U.S. Treasury yields, reigniting market expectations that the Federal Reserve will cut rates before September.

Meanwhile, investors will closely monitor economic data released by Chile for signs of slowing inflation or sustained economic growth. In December, Chile's economic activity grew by 6.6% year-on-year, marking the fastest growth rate in nearly three years.

Kaimen said, "I still don't believe the central bank will raise rates, but I could be wrong in my judgment. I think we will have a clearer assessment after the next batch of data is released."