MUFG: EM risks exacerbated by oil, Omicron and the Fed

January 31, 2022

Since our 2022 outlooks were published wherein we advocated the need to exercise caution on EMs in 2022, three pressures are intensifying by more than we had anticipated – (i) an increasingly hawkish Fed, (ii) resolutely higher energy prices and (iii) a widening spread of Omicron – each representing an augmentation of existing challenges to the EM outlook this year.

FX views

EM FX has pared back recent gains driven by the Fed’s latest hawkish policy update, although there have been a few exceptions with the BRL and COP continuing to extend their 2022 rebounds – square focus this week is on Russian geopolitical tensions with any signs of a breakthrough allowing the RUB to rally.

Trading views

Last week offered markets a good lesson in being too complacent over Fed pricing though our central views have not altered but what we have seen is a reappraisal of tail outcomes – we are beginning to change our constructive EM Asia views with China’s zero COVID-19 strategy working against the RMB.

Week in review

Over the previous week, South Africa hiked its repo rate by 25% as expected, the Central Bank of Turkey revised up its inflation trajectory and emphasised a “liraisation strategy” as crucial to the disinflation process, and Russian geopolitical tensions have gone from bad to worse.

Week ahead and calendar

For the week ahead, January PMI readings will offer a gauge of how corporates are navigating Omicron (our reading is that lockdown fatigue and softer restrictions to not dent activity as much as was the case with Delta) – separately, we have Egypt rates (hold 8.25%) and Czech rates (+75bp to 4.50%).

Forecasts at a glance

We expect the ongoing easing of pandemic effects to continue supporting recoveries, although the going will get tougher in EMs – key risks stem from a tightening in global financial conditions and a lower gear in China.

Core indicators

EM capital reversed its eight consecutive weeks of inflows to register USD-3.3bn in outflows, led by equity funds (USD-3.0bn) – the tightening in global liquidity conditions is beginning to weigh in on EM flows.