MUFG: Declining headline, persistent core bodes ill

May 10, 2023

Given the strength of underlying inflationary pressures, our front-end interest rate views are more hawkish than market pricing.

‘Despite some cause for optimism on the outlook for EM EMEA growth, it is difficult to extend that optimism to inflation. On the positive side, headline inflation rates across EM EMEA have (finally) started to decline, driven by strong base effects in energy and food inflation. However, notwithstanding the declining trend, inflation data in EM EMEA has continued to surprise to the upside in recent months, driven by stronger-than-expected core inflation dynamics.

Even if one takes a relatively optimistic view on the outlook for global inflation, the ongoing rise in underlying inflationary pressures and the de-anchoring of inflation expectations in EM EMEA economies are reasons to expect high inflation to prove more persistent. Given the strength of underlying inflationary pressures, our front-end interest rate views are more hawkish than market pricing across most of the region (notably for the CEE-4, Egypt, Russia and Turkey) and do not anticipate any rate cuts until 2024.

FX views

Emerging market currencies have strengthened on the whole against the USD over the past week. They have derived support from last week’s less hawkish policy update from the Fed that has reinforced market expectations that it has reached the end of their hiking cycle. While the Fed did not explicitly signal that it had paused their hiking cycle, we believe there is a higher hurdle now for further hikes in the near-term.

While we think carry trades could unwind, it is hard to go against such a strong trend. Better to put on paid rates positions in some local markets. Turkish elections may be very closely watched by locals but contagion to broader EM universe should be limited for now, big positive reaction may have some effect but that is a month or more down the line.

Week ahead

This week we will have rates decisions in Poland and Romania. April CPI data will be released in Hungary, the Czech Republic, Romania Egypt and in Russia – all of which are set to show headline inflation easing last month (albeit core remaining elevated in most places). Beyond EMs, the main data print that investors will be focusing on will be the US CPI release on 10 May.’