Emerging Markets | Monetary Policy & Inflation
The past week or so saw a recovery in almost all risk markets, including emerging markets (EM). So is all well in EM? We’d be more cautious. For one, growth expectations have collapsed just like in developed markets (DM). But unlike DM, inflation expectations remain high (Chart 1). This is likely due to the greater weighting towards food in CPI calculations across the EM world (DM has a higher weighting to housing). This raises the spectre of a stagflation in EM – which typically is a poor environment for local risk markets.
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The past week or so saw a recovery in almost all risk markets, including emerging markets (EM). So is all well in EM? We’d be more cautious. For one, growth expectations have collapsed just like in developed markets (DM). But unlike DM, inflation expectations remain high (Chart 1). This is likely due to the greater weighting towards food in CPI calculations across the EM world (DM has a higher weighting to housing). This raises the spectre of a stagflation in EM – which typically is a poor environment for local risk markets.
What makes matters worse is EM central bank policy rates have also collapsed (Chart 2). This makes EM yields less attractive, but also reveals that – right now at least – EM central banks care more about the weakness in growth than any incipient inflation. Together, these suggest that real yields in EM markets are likely to fall.
Of course, while we like to talk about EM as one grouping, it is rather a collection of quite diverse economies. Those likely to be most vulnerable in any relapse in risk appetite would be both ones with current account deficits, as they require a steady international inflows, and ones that have weak health systems given the COVID outbreak. Countries that meet both criteria include India, Indonesia, Colombia, Mexico and Turkey. Keep an eye on them in coming months.
Chart 1: Consensus EM Forecasts For Current Year:
Collapsing Growth, Sticky Inflation
Source: Bloomberg, Macro Hive
Chart 2: EM Policy Rates Have Fallen Sharply
Source: Bloomberg, Macro Hive
Bilal Hafeez is the CEO and Editor of Macro Hive. He spent over twenty years doing research at big banks – JPMorgan, Deutsche Bank, and Nomura, where he had various “Global Head” roles and did FX, rates and cross-markets research.
(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)