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EM easing cycle to widen out

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

Diminishing US growth exceptionalism and the Fed’s articulation that the start of the easing cycle is imminent should relax the constraints on EM policymakers and support a widening out of the EM rate easing cycle. Through the remainder of the year we expect central banks in Philippines, Singapore, South Africa, South Korea, Taiwan and Turkey to join their early-cutter peers in LatAm and CEE and initiate their rate-cutting cycles. Driving this accommodative monetary momentum in our view is the easing in external market and inflationary constraints which should offer the space for EM central bankers to become more sensitive to domestic growth developments, with the recent activity indicators relatively weak across the CEE region, South Africa and South Korea. From a rates positioning perspective, worsening US growth has also come with a sizable steepening of the US yield curve which has not played out to the same degree in the recent EM rates rally. Though, as more EM central banks to turn dovish, and become more closely aligned to the apprehensions surrounding the domestic growth cycle, we believe there is likely to be more curve steepening across the EM complex (notably in Czech Republic, Mexico and South Korea).

FX views

Notwithstanding recent market turbulence, the US economy looks close to achieving a soft landing, with the Fed likely to deliver the first non-recessionary cut in September, with FX markets seemingly pricing this as a time to short the USD. From one lens this is fathomable as the Fed can and may adjust real rates more rapidly than other central banks and as long as softer growth does not evolve into recession and does not spill over to other major jurisdictions, the left tail of the “dollar smile” is likely to remain some ways away. Fed Chair Powell’s remarks left no room for vagueness on the directional trajectory for policy rates now, and it is challenging to contend against USD shorts a month before a cutting cycle commences. From an EM perspective, as risk sentiment has recovered from its early August scare, the LatAm high-beta, high-carry currencies have appreciated most sharply, with EM Asia low-yielding currencies equally having held onto their gains. We view that the outperformance of high carry versus low carry currencies of the last couple of years (i.e. between EM FX and G9 FX) will be increasingly driven by the carry component, especially as carry levels have stabilised after falling through 2023. However, the spot performance between the two groups is likely to be more balanced as we move away from a higher-for-longer regime but global activity is still holding up.

Week in review

The Central Bank of Turkey (CBRT) kept its policy rate at 50.00%, with a tightening bias. Inflation in South Africa edged lower from 5.1% y/y in June to 4.6% y/y in July, offering the South African Reserve Bank (SARB) the space to ease rates before year-end. Real GDP in Israel surprised to the downside (1.2% q/q annualised in Q2 204 from 17.3% q/q in Q1 2024), owing to tepid investment growth. Finally, the Egyptian authorities are set to raise electricity prices by 14.5% to 50% from September, following the increase in electricity generation costs in March.

Week ahead

There will be rates meetings in Hungary (MUFG and consensus: on hold at 6.75%) and Israel (MUFG and consensus: on hold at 4.50%). August CPI data will be released in Poland (MUFG and consensus: +0.1ppt to 4.3% y/y).

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.

Core indicators

The latest weekly IIF flow data signalled that EM securities witnessed USD0.8bn of outflow in the week ending 16 August – fifth consecutive week of outflows from the EM complex. We reiterate that the relationship between EM currencies and Fed decisions are crucial – higher rates normally strengthens the US dollar, diminishing the appeal of EM currencies, which can lead to capital outflows and increased borrowing costs for EM.