Emerging market rate cuts will kick-off this month

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

RAMYA RS
Analyst
DIFC Branch – Dubai
T:+971 (4)387 5031
E: ramya.rs@ae.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

PAUL FAWDRY
Head of Emerging Markets FX Desk
Emerging Markets Trading Desk
T: +44(0)20 577 1804
E: paul.fawdry@uk.mufg.jp 

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

Macro focus

With broadening disinflation, moderating inflation expectations, relatively high real rates in places, and a supportive FX backdrop, we are at the point where the first rate cuts from EM central banks in this cycle appear imminent. This stands in sharp contrast to DM central banks that are still delivering late-innings hikes. As was the case with the EM hiking cycle back in early 2021, LatAm is likely to lead the way (see here), with Chile the likely first mover this month, with Brazil in August and Poland thereafter in September. Whilst our monetary policy models – anchored on Taylor rule type fair values of short-term rates – suggest that other EMs will join chorus of rate cuts in H2 2023, we believe the current aggressive market pricing for cuts will be tested, and underdelivery would likely lead to more curve inversion. If the EM rate-cutting cycle proceeds more gradually than markets currently expect, we think the terminal rate pricing still has room to move lower, during which we see scope for the belly and the long end to perform well across most EM markets.

 

FX views

Last week saw a reversal of trends that have been in place for most of this year. Firstly, Asian currencies have staged a modest rebound including the CNY, KRW and THB. At the same time, it has been reported that China’s largest banks have cut rates available for corporate US dollar deposits for the second time in a matter of weeks to help ease the relative attractiveness of holding US dollars. Last week saw a reversal of trends that have been in place for most of this year. Firstly, Asian currencies have staged a modest rebound including the CNY, KRW and THB. At the same time, it has been reported that China’s largest banks have cut rates available for corporate US dollar deposits for the second time in a matter of weeks to help ease the relative attractiveness of holding US dollars.

 

Week in review

The National Bank of Poland (NBP) kept rates on hold at 6.75% but guided towards a rate cut in September. Inflation in Hungary feel by 1.4ppts to 20.1% y/y in June, in line with the National Bank of Hungary’s expectations. Headline inflation in Turkey declined by 1.4ppts to 38.2% y/y in June mostly on base effects, whereas core inflation rose by 0.7ppts to 47.3% y/y in June, driven by a significant Lira depreciation (TRY weakened by 20.4% against the US Dollar in June) on top of sticky services inflation.

 

Week ahead

This week, we will have the rate decision in Israel (MUFG and consensus on hold at 4.75%) and June CPI data will be released in Russia, the Czech Republic, Romania, Poland and Israel (all set to decline bar Russia). Finally, May and Q2 2023 BoP data will be published in Turkey and Russia, respectively (both set to weaken).

 

Forecasts at a glance

In a world of tightening global financial conditions and questions about the liquidity implications of the now-finalised US debt ceiling, we see a degree of macro risks for EM economies in H2 2023, with external funding requirements the central concern. We expect EM growth to trough this year but remain below potential in the 2024 recovery. The silver lining is that subdued growth should cap inflation, facilitating monetary policy easing where external balances allow.

 

Core indicators

According to IIF data, in the week ending 07 July, total inflows from EM funds were at USD0.9bn, of which USD0.7bn was into EM equity funds while USD0.2bn was into EM bond funds.