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Contextualising EM reverberations should the Fed keep rates higher for much longer

EHSAN KHOMAN
Head of Commodities, ESG and
Emerging Markets Research –
EMEA
DIFC Branch – Dubai
T:+971 (4)387 5033
E: ehsan.khoman@ae.mufg.jp

SOOJIN KIM
Research Analyst
DIFC Branch – Dubai
T: +44(4)387 5031
E: soojin.kim@uk.mufg.jp

LEE HARDMAN
Senior Currency Analyst
Global Markets Research
Global Markets Division for EMEA
T: +44(0)20 577 1968
E: lee.hardman@uk.mufg.jp

MUFG Bank, Ltd.
A member of MUFG, a global financial group

Macro focus

Whilst the economy is slowing, US resilience relative to earlier expectations and stickiness in the disinflation process have prompted risks of a higher-for-longer Fed. From an EM lens, central banks’ monetary policies should primarily be driven by domestic objectives centred on inflation targets and/or output gap considerations. As such, for a hawkish stance in the Fed’s trajectory to significantly influence EM monetary policy, we would need one (or both) of the following channels to transpire. First, that Fed hawkishness driven by domestic macro strength has material economic spillovers via trade that would markedly influence the direction of EM monetary policy. Second, if the transmission of Fed policy via exchange rate spillovers via capital flows and balance sheets, poses financial and inflation stability risks that would effect EM central bank policies.

FX views

Emerging currencies have continued to rebound over the past week driven in part by a further correction lower for the USD after the release of the weaker US CPI and retail sales reports for April. Meanwhile, recent developments in China have attracted more market attention over the past week although have had only a modest impact on emerging market currency performance.

Week in review

Romania kept rates on hold at 7.00% indicating that inflation will continue to decline, but at a slower pace than previously forecasted. Turkey’s current account deficit narrowed in March. Israel’s and Czech Republic’s inflation for April surprised to the upside.

Week ahead

In the upcoming week, there will be MPC meetings in Hungary (21 May), Nigeria (21 May), Egypt (23 May) and Turkey (23 May). The April CPI print will also be released in South Africa (22 May).

Forecasts at a glance

Growth across the EM universe is set to stabilise as domestic fundamentals offset external drags, with some rotation from the largest to smaller EMs. Inflation and interest rates are both “over the hump” – disinflation is progressing, and the decline in rates will continue and broaden in 2024 (see here).

Core indicators

According to the IIF, EM fund flows attracted USD0.4bn in the week ending17 May – fourth consecutive week of inflows.