EM’s Breakaway Doves
21 April 2023
Read Time 2 MIN
Global Rate Cycles
While advanced economies are still debating the extent of additional monetary tightening – just check today’s services PMIs in Europe/U.S. and think about potential inflation pressures this can generate (see chart below) – some emerging markets (EM) already started to cut policy rates. The central bank of Uruguay surprised with a 25bps rate cut yesterday, and Costa Rica delivered its second rate cut in a row (100bps after 50bps in March). The market still gets apprehensive about premature policy easing in EM – and there are good reasons for that (such as 20% annual inflation in Hungary, for example). High real rates also helped to shield EMs during this year’s market turbulence in Europe/U.S. (mini-banking crisis) – something to keep in mind as we get closer to the debt ceiling debate in the U.S., which can lead to a spike in FX volatility. Expected U.S. investment curbs against China can affect the market sentiment as well.
EM Easing Prospects
EM’s “dovish rebellion” is still small – many central banks are happy to pause, but not yet ready to pivot. This was a key message from the Indian central bank’s minutes released yesterday, and they came on the heels of an even more hawkish signal from the Chilean central bank’s transcript. The Brazilian central bank expressed concerns about sticky inflation expectations, the Malaysian central bank left the door open for more tightening and the Czech national bank warned the market against betting on rate cuts. Rate hikes in EMs are rarity these days, but upside inflation surprises have forced the central bank’s hand on more than one occasion – including South Africa (+50bps in March) and Argentina (+300bps yesterday). Argentina, of course, is a very special case – the economy is a train wreck – but it might get interesting because the difficult economic situation improves centrists’ electoral chances (hence, the outlook for reforms) in October.
Inflation Risks
Another reason to keep an eye on Argentina is mega drought and its potential impact on food prices, which account for a significant portion of a typical consumer price basket in EM. Stronger than expected domestic activity can also create headache for EM central banks, which look to exit their tightening cycles. Potential spillovers from a faster than expected China recovery fall into this category, and China’s comments about the U-shape inflation/credit time lags did not go unnoticed. So, while EM doves’ policy choices look gutsy, it could be a very bumpy flight.
Chart at a Glance: Global Growth Drivers – Services Recovery Continues
Source: Bloomberg LP.
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