Summary
- Emerging markets have seen a sustained period of higher nominal yields over the past 18 months.
- This backdrop of moderating inflation raises the question of whether there is light at the end of the tunnel for monetary policy tightening.
- We do not expect cuts in the very near term given still-elevated inflation profiles and deeply negative real rates.
- Our overall duration stance is close to neutral.
By Sukhjeet Reehal
Emerging markets have seen a sustained period of higher nominal yields over the past 18 months, driven by surging inflation and monetary policy tightening. In addition, their central banks have had to deal with external shocks that have affected regions differently, with the war in Ukraine’s effect on European energy prices and China’s zero-COVID policy being two such examples.
Despite unprecedented shocks, inflation momentum and inflation surprise indices have started to moderate in much of the emerging markets, and we believe that inflation, in aggregate, will peak in the coming months. The main disinflationary drivers have been lower energy prices (excluding Central and Eastern Europe) and, to a lesser extent, food prices. While there is clearly much differentiation among countries and regions, this backdrop of moderating inflation raises the question of whether there is light at the end of the tunnel for monetary policy tightening.
In contrast to the highly accommodative stance by emerging market central banks to the COVID shock, the cumulative increase in policy rates across the three regions (Asia, EMEA, LatAm) since 2018 has been dramatic. EMEA and LatAm policy rates are now, on aggregate, significantly higher than pre-COVID levels; whereas, in Asia, rates are yet to return to pre-COVID levels.
Recently, we have seen a repricing of monetary policy expectations in some emerging markets, in an environment where Federal Reserve and European Central Bank terminal rate expectations are still moving higher. In June 2022, 18 out of 19 liquid emerging markets were priced for rates to remain on hold or tighten over the subsequent 12-month period. In September, that number had fallen to 13 countries. This dovish pivot comes amid slowing inflation momentum and growth concerns, as evident by the sequential Q2 GDP slowdown across much of the emerging markets.
That said, we do not expect cuts in the very near term (excluding in Turkey) given still-elevated inflation profiles and deeply negative real rates in the case of Central and Eastern Europe. The risks to this view of terminal rates being in sight come from further supply-side shocks in energy and food, tightening global financial conditions leading to currency depreciation (higher imported inflation), and expansionary fiscal policies.
Our overall duration stance is close to neutral, with a preference of holding overweight duration positions in Brazil, Mexico and South Africa, a neutral stance in CEE with a steepening bias, and an underweight in Asia (excluding China) duration.
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For further details see:
Emerging Markets: Are Terminal Rates In Sight?