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EM Policy Options - To the Drawing Board

August 11, 2022

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Recent changes in inflation and growth surprises are making emerging markets to re-evaluate their policy options.

EM Inflation, Growth Surprises

The inflation surprise index for emerging markets (EM) has been going down since May. The growth surprise index appears to be flat lining. It is therefore not surprising that an increasing number of EMs are going back to the drawing board to evaluate their policy options. In China, the central bank’s Q2 monetary policy report signaled that “a wall of liquidity” will not be coming back any time soon, despite benign inflation and multiple near-term growth headwinds (the 2022 consensus GDP growth has been cut to 3.9%). The chart below - with interbank rates well below their benchmark - shows why additional rate cuts might not be a policy option of choice either (there is no point), and why authorities are likely to focus on regulatory changes and fiscal channels.

Growth and Pace of EM Rate Hikes

Near-term growth headwinds might be even stronger in Central Europe, which is exposed to higher energy prices and negative spillovers from its main trading partner, the Eurozone. The Czech National Bank kept the policy rate on hold, opting for FX interventions (about 15% of the international reserves since mid-May, according to some sell-side estimates) to cap inflation pressures. Hungary is actively employing fiscal tightening (a surprising surplus in July) in addition to more aggressive benchmark frontloading. So, today’s decision to keep the 1-week deposit rate unchanged looks perfectly logical in all respects. Finally, today’s minuscule downside surprise in Romanian inflation can give the central bank an excuse to tighten at a slower pace going forward.

LATAM Policy Divergence

The inflation and growth landscapes in LATAM look quite diverse. Brazil is exiting its tightening cycle - and rightly so. But other countries/central banks might need to work harder (=hike more) to leave the inflation peak behind. Mexico’s rate-setting meeting will be closely watched this afternoon. The consensus expects another sizable hike of 75bps, following an upside inflation surprise in July. But the statement will be equally important as regards the balance of risks and especially the central bank’s view on growth risks, because Mexico’s manufacturing survey (Purchasing Managers Index) unexpectedly moved into contraction zone in July (48.5). Stay tuned!

Chart at a Glance: China Interest Rates - Lower Without Policy Rate Cuts

Chart at a Glance: China Interest Rates - Lower Without Policy Rate Cuts

Source: Bloomberg LP

PMI – Purchasing Managers’ Index: economic indicators derived from monthly surveys of private sector companies. A reading above 50 indicates expansion, and a reading below 50 indicates contraction; ISM – Institute for Supply Management PMI: ISM releases an index based on more than 400 purchasing and supply managers surveys; both in the manufacturing and non-manufacturing industries; CPI – Consumer Price Index: an index of the variation in prices paid by typical consumers for retail goods and other items; PPI – Producer Price Index: a family of indexes that measures the average change in selling prices received by domestic producers of goods and services over time; PCE inflation – Personal Consumption Expenditures Price Index: one measure of U.S. inflation, tracking the change in prices of goods and services purchased by consumers throughout the economy; MSCI – Morgan Stanley Capital International: an American provider of equity, fixed income, hedge fund stock market indexes, and equity portfolio analysis tools; VIX – CBOE Volatility Index: an index created by the Chicago Board Options Exchange (CBOE), which shows the market's expectation of 30-day volatility. It is constructed using the implied volatilities on S&P 500 index options.; GBI-EM – JP Morgan’s Government Bond Index – Emerging Markets: comprehensive emerging market debt benchmarks that track local currency bonds issued by Emerging market governments; EMBI – JP Morgan’s Emerging Market Bond Index: JP Morgan's index of dollar-denominated sovereign bonds issued by a selection of emerging market countries; EMBIG - JP Morgan’s Emerging Market Bond Index Global: tracks total returns for traded external debt instruments in emerging markets.

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