Peak Inflation = Peak Rates?
26 July 2022
Read Time 2 MIN
Brazil Inflation, Frontloading
Moderating mid-month inflation in Brazil gave us hope that peak-inflation might actually be real. Headline inflation eased a tiny bit more than expected to 11.39% year-on-year – an encouraging sign for the consensus expectations that see inflation falling to 8.5% by the end of the year and further to 6% in 12 months. For this scenario to materialize, it is important that (a) the inflation diffusion index continues to go down, and (b) the government does not get carried away by its fiscal successes and stops expanding its spending plans. If this happens, Brazil would have by far the highest real policy rate among major emerging markets (EM) (see chart below), which should give it plenty of space to finish its tightening cycle in September, and maybe start thinking about rate cuts sometime in 2023.
EM Real Policy Rates
The most incredible point about the chart below is not Brazil’s sky-high real policy rate, but that it is followed by Hungary, which until recently was among EM policy laggards. And it was duly punished by the market, having posted the second worst local debt return so far this year (in the J.P. Morgan’s GBI-EM Index). But if you have the same inflation as in Brazil (11.7% year-on-year), perhaps your central bank should adopt Brazil’s response function – which means aggressively frontloading rate hikes. Hungary did not disappoint today, raising its policy rate by 100bps more (after a double punch of +185bps and +200bps). So, Hungary’s policy rate is now in double digits for the first time since the global financial crisis of 2008/09 – and, as we just said, the real policy rate adjusted by expected inflation is now the second highest in EM. This created a significant policy cushion, but it’s absolutely critical to proceed with fiscal adjustment, as spending got a bit out of control in the run up to the elections.
Terminal Rates in DM
The notion of peak rates features prominently in developed markets (DM) discussions as well. Today’s weaker than expected Conference Board consumer confidence index in the U.S. raised additional concerns about the Q3 growth headwinds – right in the run up to the U.S. Federal Reserve’s (Fed’s) meeting tomorrow. The expectation (measured by the Fed Funds Futures) is still for a 75bps rate hike, but the market sees no additional hikes after December. A series of downside activity surprises in the Eurozone – and negative headlines about the Russian gas exports’ disruptions – depressed the market expectations for the European Central Bank (ECB), which is now expected to take a pause after March 2023. Stay tuned!
Chart at a Glance: Real Policy Rates in EM – Some Central Banks Get It
Source: VanEck Research; Bloomberg LP
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