MUFG: Emerging market implications from an earlier Fed tightening strategy

MUFG: Emerging market implications from an earlier Fed tightening strategy

November 2, 2021

Emerging Markets Monetary policy
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Investors are increasingly pricing in expectations of an earlier Fed tightening with US inflation set to remain persistently elevated when the taper likely concludes next year, and thus raising prospects of another “taper tantrum” for EMs, as it did in 2013.

However, we view that a tighter Fed stance will not cause the same carnage given the Fed’s well-articulated communication strategy, and the fact that EMs have become more resilient through healthier external balances thanks to reduced financing needs, increased reserve buffers and less overvalued currencies.

FX views

With the current external environment challenging for EMs amidst slowing global growth and building concerns over the risk of a more persistent period of higher inflation, EM FX have come back under broad-based selling pressure with higher yielders – ZAR, MXN, RUB and BRL – particularly hard hit as the US fixed income volatility has picked up and undermined the attractiveness of carry trades.

Trading views

Light positioning in the EM space signals that we don’t envisage any taper tantrums irrespective of the Fed’s communication strategy, however we do foresee EM current accounts mattering more going forward.

Week in review

Over the previous week, Egypt maintained rates (8.25%), the Turkish Central Bank raised its inflation forecasts (18.4% y/y and 15.2% y/y for end-2021 and end-2022, respectively) and Czech Q3 GDP surprised to the downside (1.4% q/q).

Week ahead and calendar

In the coming week, we have rates meetings in Poland and Czech Republic, October inflation data in Turkey and Russia and October PMIs.

Forecasts at a glance

The recovery in EM economies continued at a robust pace during H1 2021 – though peak growth has passed, strong DM growth and the easing of pandemic effects, should support EM recoveries over the remainder of the year.

Core indicators

EM capital flowed out last week (USD-0.4bn) as stagflationary apprehensions and persistent COVID-19 uncertainties warranted investor caution.

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