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Finding the Right Balance

December 08, 2021

Read Time 2 MIN

 

Poland chose to slow the pace of rate hikes at today’s rate-setting meeting. Will the rapidly deteriorating growth outlook lead to a similar policy adjustment in Brazil?

The latest inflation and domestic activity indicators in emerging markets (EM) made us focus even more on central banks’ response functions – especially as regards room for additional policy tightening. Hungary’s huge upside inflation surprise means that annual inflation in three out of four Central European economies is running well above 7% (and much higher than the target ranges). LATAM’s inflation heatmap is also “on fire”. There are suggestions that inflation is peaking – the question is whether central banks’ appetite for aggressive rate hikes in EM is peaking as well, just as the U.S. Federal Reserve started to contemplate policy normalization.

Poland’s decision to raise its policy rate in line with expectations (50bps to 1.75%) this morning might look a bit underwhelming – after all it comes on the back of Governor Adam Glapinski’s dramatic inflation U-turn (from “transitory” to “non-transitory”, “burdensome”, and being “the main concern”). Further, Poland’s real policy rate is still among the lowest in EM - when adjusted both by trailing and expected inflation. However, the central bank had already delivered 165bps of hikes since October. So it’s still very much a “hike, baby, hike!” scenario, but not at breakneck speed.

Rate-setting meetings in Brazil (later today) and Hungary (next week) will also be closely watched. Brazil’s case is especially interesting – (1) we are getting closer to the presidential elections (which often lead to a more expansionary fiscal stance and produce a lot of noisy headlines); and (2) we might be seeing the first red flag in EM as regards the impact of aggressive tightening on the growth outlook. Pretty much all recent activity indicators for Brazil surprised to the downside, and Brazil’s consensus growth forecast for 2022 had been cut to mere 1.1% - the lowest among major EM (see chart below). Are we seeing a lagged impact of cumulative 575bps of rate hikes since March? Many years ago in the U.S., the Fed Chairman Paul Volcker1used aggressive policy tightening to kill inflation. He succeeded, but growth was a major casualty. Will the Volcker approach to inflation/rates in parts of EM have a similar impact on the 2022 growth outlook? Stay tuned!

Chart at a Glance: Brazil Growth – Red Flag or False Alarm?

Chart at a Glance: Brazil Growth – Red Flag or False Alarm?

Source: Bloomberg LP

1Paul Adolph Volcker Jr. was an American economist. He served two terms as the 12th Chair of the Federal Reserve under U.S. presidents Jimmy Carter and Ronald Reagan from August 1979 to August 1987.

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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