Testing the Status Quo in EM

24 April 2023

Read Time 2 MIN

The consensus is optimistic on the pace of disinflation. But is it enough to start rate cuts in EM?

Consensus View on Growth, Inflation

The softer landing story – back in vogue after the IMF spring meetings – continues to drive the near-term market expectations for policy rates in developed markets (DM), with swap curves implying the U.S. “farewell” rate hike in May, and about 85bps of additional tightening in the Eurozone. The U.S. Federal Reserve (Fed) expectations firmed up quite a bit after the mini-banking crisis in March, but the consensus continues to see room for rate cuts on the 6-12 months horizon, betting that inflation pressures will continue to subside. The emerging markets (EM) debt team found this to be the common view at the recent spring meetings and we think that the consensus might be too optimistic, albeit higher real interest rates in EMs place them in a fundamentally safer position to start policy easing. 

Rate Pause or Pivot?

Last week, Uruguay delivered its inaugural rate cut and the Costa Rican central bank cut the policy rate for the second time in a row. The market was not super-excited about the moves, but the reaction was muted compared to what happened to the Hungarian forint after suggestions that the central bank might start cutting some interest rates as soon as tomorrow. For now, most EM central banks are following the IMF’s advice to remain cautious and not communicate rate cuts prematurely. We expect Colombia to follow suit on Friday with a hawkish hold. Colombia’s economy is definitely slowing down, the currency’s appreciation should help to cap price pressures going forward, and the fiscal gap is expected to narrow this year, but inflation – especially core – is yet to peak.

Conditions for EM Rate Cuts

Mexico has even more reasons to pause in May, following softer than expected bi-weekly inflation prints this morning (see chart below). The local swap curve implies that the policy rate has peaked, and that there is room for rate cuts in Q4. Brazil’s example, however, shows that successful disinflation might be enough to pause, but not enough to initiate, rate cuts in EM. Brazil’s real policy rate is the highest in EM, and mid-month inflation is expected to fall below 5% year-on-year this Friday. Still, concerns about sticky inflation expectations and the government’s fiscal plans keep the central bank on defensive, and the market sees the first rate cut only in the fall.

Chart at a Glance: Mexico – Policy Rate Pause at Last?

Chart at a Glance: Mexico – Policy Rate Pause at Last?

Source: Bloomberg LP


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