EM Central Bank Update - Hawkish Wave

October 07, 2021
The hawkish wave continues to sweep more EM central banks, while isolating the remaining dovish few. In this report we elaborate on the recent changes in Poland, Colombia, Brazil, South Africa and South Korea. In short, we suspect that the hawkish surprises will continue as countries face growing inflation pressures and the benefits of front-loading the tightening cycles become more attractive. We are not in a carry trade environment (volatility is too high), but higher rates and pro-active central banks should cushion local currencies against bouts of risk aversion and broad dollar strength, and in some cases (like Brazil) we may also see direct FX intervention on top. 

The Polish Central Bank was the latest to join the hawkish shift, starting to play catch up to Hungary and Czech Republic, isolating Turkey. The first hike since 2012 came as a surprise, with all of the analysts on the Bloomberg poll calling for no change. One of the most interesting twists of this story was the comment by Prime Minister Morawiecki calling for an “appropriate” response to the inflation threat. It’s not every day that we see the government pressuring the central bank to raise rates. In the regional context, the move further isolates Turkey, with next policy meeting is October 21 and another cut then seems likely. Turkey remains the most problematic amongst major EMs, and with no end to political interference in sight, it’s hard to construct any positive narrative for local assets.
We see growing chance that the Colombian central bank (Banrep) will start front-loading the tightening cycle. The September CPI print came in at 4.51% y/y, a bit higher than expected and well above the upper end of the bank’s 2-4% target range. The accelerating price pressure was led mostly by headline items – food and energy – with core inflation easing slightly to 3.03%. Still, the hawks showed themselves in the last meeting with three of the seven MPC member voting for a 50 bp hike that was greater than the 25 bp they delivered. Their case just got stronger and we see a high chance they will win the argument at the October 29 meeting. We think this is partially priced in, as seen by the peso’s recent outperformance, but we suspect that confirming this hawkish shift will provide some additional support.
We don’t think the Brazilian Central Bank will accelerate its tightening cycle, but we see a good chance of FX intervention to support the real. After some excitement about a possible 125 bp hike last month, markets have settled back on a continued clip of 100 bp. The discussion now revolves around the extent of the cycle. We stick with our call for rates topping out around 9.0% and the recent price action on the swaps markets suggests investors are rapidly moving this way. Perhaps more importantly, we also think the central bank will soon reach its threshold for FX intervention to “smooth” out volatility. The risks are piling up for Brazil – including energy crisis, already high inflation, elections premium, negative risk sentiment. The last thing they need now is an expressive inflation passthrough from a weaker BRL.
The South Africa Reserve Bank (SARB) is undergoing a gradual hawkish shift. We thought SARB would fall well behind other EMs in the cycle give the country’s chronic economic problems such as high unemployment. But seems like we were wrong. SARB’s bi-annual policy review confirmed the renewed focus on inflation. While price pressures are mostly coming from the energy and commodity side, officials also mentioned the closing output gap and the need to avoid having to “catch-up with inflation.” This suggest a high likelihood of a hike at the November 18 meeting. Indeed, breakeven rates have been rising sharply implying a greater risk that inflation could become unanchored and the SARB should act upon it.
Bank of Korea (BOK) remains on the far hawkish end of the EM Asia spectrum, though still timid by LatAm central bank standards. Korea’s September CPI came in slightly above expectations at 2.5% y/y, reinforcing the view that the bank will remain on a tightening path. The BOK target is 2.0%, and core is running at 1.9%. The increase in headline was driven largely by transport costs and some household goods, and services to a lesser extent. This means that the BOK will likely continue to pull ahead of most Asian central banks with another hike at its November meeting, but note that even then rates will remain well below that of most other EM Asia central banks. Of course, the absolute level is nowhere near offering a substantial carry advantage.

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