EMs – All Grown Up?

EM Tightening Cycle

There were more signs of responsible policy-making in emerging markets (EM), as well as some nice macroeconomic results this morning. Central banks in Hungary and Nigeria delivered larger than expected rate hikes to combat persistent inflation pressures. Hungary’s nominal policy rate looks like it belongs in Latin America (LATAM) – at 13%, it is higher than all regional policy rates except Brazil (13.75%). There are good reasons why the Hungarian national bank had to go for another supersized hike (+125bps) – post-election fiscal adjustment is still slow, and domestic political noise adds pressure on the currency (hence, the need to “overcompensate” on the monetary front). Hungary’s example, however, underscores that EM is not a monolith – even within a region. Central banks in Poland and especially the Czech Republic are decidedly more dovish. The Czech National Bank is expected to extend its pause this week – at a mere 7% against the backdrop of 17.2% annual inflation.

Prospects For Rate Cuts In EM

Going back to Hungary’s nominal policy “neighborhood,” Brazil’s central bank minutes sounded hawkish despite signs of further disinflation. Mid-month inflation eased more than expected, dropping below 8% year-on-year (see chart below). However, not all of it was due to Brazil’s early and aggressive rate hike frontloading. Disinflation also reflected some tax cuts, which explains the central bank’s caution and intention to keep the policy rate “high” for a “sufficiently long period.” How long is “long”? Brazil’s local swap curve currently prices in rate cuts later in Q2-2023/Q3-2023. This is not impossible, provided there are no additional political complications (we are very close to the hotly contested elections) and inflation continues to move closer to the target range.

EM Easing And Exchange Rates

Brazil’s credible policy response to the inflation surge is one of the reasons why the Brazilian real remains one of the best performing global currencies so far this year. EMs are generally praised for tightening much earlier than developed markets (DM) peers in this cycle. “Grown-up” policies? Yes. But the real test for EMs might be their ability to start earlier policy easing without adverse consequences for economic fundamentals or asset prices. China’s easing (including small rate cuts) added to deprecation pressures on the currency, forcing authorities to step up policy support for the renminbi. So, it is not that simple. Stay tuned!

Chart at a Glance: Brazil Disinflation – Nice Optics*

Source: Bloomberg LP

*Brazil IPCA-15 CPI Extended National YOY Index - Index that measures Brazil’s YoY Consumer Price Index. IPCA is the benchmark inflation index observed by the Central Bank of Brazil.