First in, first out – examining early hikers and rate cuts across EMs

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

We catalogued earlier this month that EM rate cuts are set to kick-off, with Chile the first mover (see here). In a unanimous decision, the Banco Central de Chile delivered a 100bp rate cut to bring rates to 10.25% on 28 July. In this cycle, Chile and eight other EM central banks commenced rate hikes around 6-12 months earlier than in major DMs, which led to more frontloading tightening in financial conditions that in-turn led to a more frontloaded impact on economic activity and inflation. Despite mixed messaging from central banks, we forecast these early hikers to cut be the first to cut rates over the next three quarters. This is reflecting progress on inflation, a greater stress by these central banks on neutral rates when evaluating the policy stance, as well as apprehensions about keeping their exchange rates high for an extended period.

 

FX views

Inflation relief has been flowing through EM markets while the activity data has remained resilient. We view that the main implication from this more benign mix of growth and inflation for EM FX is that investors should consider not only high nominal carry, but also dial up the cyclical beta of portfolios. On carry specifically, nominal EM carry levels have continued to decline from their peak in late 2022. As such, while carry will continue to contribute positively to the relative total return performance between EM and G9 FX, we anticipate this to become less instrumental than in the last two years. In terms of cyclical exposures, our screening for FX sensitivities to both the broad USD and cyclical versus defensive equities signals that MXN and INR are among the most defensive carry plays in EM FX given their elevated carry-to-vol and resilience to broad USD moves.

 

Trading views

We continue to be in the middle of the USD smile but have concerns about growth prospects. The reasons to be positive EM on falling yields get smaller if we’re talking growth downgrades instead of disinflation. Receiving EM rates however can benefit from both growth downgrades and disinflation.

 

Week in review

Hungary kept base rates on hold at 13.00% and continued with one-day deposit rate cuts (-100bp to 15.00%). Lower volumetric oil production drive Saudi Arabia’s Q2 2023 GDP lower (1.1% y/y), compared with 3.8% y/y in the previous quarter. Finally, Nigeria hiked by a token 25bp to 18.75%, taking rates to the highest in 22 years.

 

Week ahead

This week, we will have rates meetings in Egypt (MUFG and consensus on hold at 18.25%) and the Czech Republic (MUFG and consensus on hold at 7.00%). June’s inflation data will be released in Turkey (MUFG: 47.8% y/y; consensus: 46.8% y/y). Finally, we will have July PMIs for the EM EMEA region released which we will be closely watching to see if the trend will follow DM PMIs lower.

 

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, the weekly inflows into EM bond funds were at USD0.8bn, while outflows from EM equities were at USD1.1bn in the week ending 21 July.