INTRODUCTION
Some Emerging Market central banks are already easing or about to start easing. However, market pricing is very aggressive and we do not think such aggressive easing will be possible without significant currency weakness when major central banks are still tightening. This is a careful balance that must be struck by EM policymakers and we do not think all of them are up to the task.
RECENT DEVELOPMENTS
It’s still too early to call the end of the Developed Markets tightening cycles. Each month brings continued upside surprises to the data across many major economies. The breadth and pace of the monetary tightening cycle has been staggering and it’s going to go on for much longer than markets expected. Even when the hikes end, interest rates are likely to remain high for quite some time even as Quantitative Tightening (QT) will continue apace. In other words, markets are too complacent about the global liquidity and growth outlook.
EM central banks front-ran the Fed during the tightening cycle. The top EM performers YTD are COP, MXN, BRL, HUF, PLN, and RON. It’s no surprise that all of these top performers are amongst the highest yielding in EM, which has helped their currencies hold up in the face of a negative EM environment. On the other hand, these Emerging Markets tightening cycles have largely ended and we are on the cusp of the easing cycles.
EM central banks are also front running the Fed during the easing cycle. However, there will be limits to how fast and how low they can go. With EM still seen as a risky asset class, interest rates differentials can’t narrow too much before their currencies start to weaken significantly. We are already seeing that in HUF, which outperformed in H1 but is underperforming in H2 as aggressive easing continues.
Hungary has already started cutting rates and Chile is up next this Friday. Brazil is likely to start cutting rates in early August. Below, we set out the expected rate paths for the major EM countries. We believe market pricing in many instances is way too aggressive. If some central banks were to cut as much as the market has priced in, their currencies are likely weaken significantly due to narrowing interest rates differentials. In turn, that could hurt the inflation outlook due to the pass-through.
AMERICAS
Brazil: Began hiking March 2021; 1175 bp of tightening so far; no more hikes priced in; easing cycle priced to start August 2 with a 50 bp cut; 100 bp of total easing is seen over the next three months followed by another 125 bp over the subsequent three months; policy rate seen bottoming at 9.5% over the next twelve months; this seems too hawkish
Chile: Began hiking July 2021; 1075 bp of tightening so far; no more hikes priced in; easing cycle priced to start this Friday with a 75 bp cut; 200 bp of total easing is seen over the next three months followed by another 200 bp over the subsequent three months; policy rate seen bottoming at 4.25% over the next two years; this seems too dovish
Colombia: Began hiking September 2021; 1150 bp of tightening so far; no more hikes priced in; easing cycle priced to start in Q3; 50 bp of total easing is seen over the next three months followed by another 125 bp over the subsequent three months; policy rate seen bottoming at 7.25% over the next two years; this seems about right
Mexico: Began hiking June 2021; 725 bp of tightening so far; no more hikes priced in; easing cycle priced to start in Q4; no easing is seen over the next three months followed by 50 bp over the subsequent three months; policy rate seen at 7.0% over the next three years; this seems about right
Peru: Began hiking August 2021; 750 bp of tightening so far; no more hikes priced in; easing cycle priced to start in Q3; 25 bp of total easing seen over the next three months followed by 75 bp over the subsequent three months; policy rate seen at 4.5% by end-2024; this seems about right
EMEA
Czech Republic: Began hiking June 2021; 675 bp of tightening so far; 50 bp of hikes priced in; easing cycle priced to start in Q4; 50 bp of total hiking seen over the next three months followed by 100 bp of easing over the subsequent three months; policy rate seen bottoming at 3.0% over the next three years; this seems too dovish
Hungary: Finished hiking when it introduced 1-day deposit rate at 18% in October 2023; began easing cycle in May with 100 bp cut to this new rate followed by another 100 bp cut in June; the bank’s implied aim is to cut this rate 100 bp per month until it converges with the 13% base rate; 125 bp of easing in the base rate is seen over the next three months followed by another 275 bp over the subsequent three months; base rate seen at 3.25% over the next three years; this seems too dovish
Israel: Began hiking April 2022; 465 bp of tightening so far; no more hikes priced in; easing cycle priced to start in 2024; no easing seen over the next six months; policy rate seen at 3.0% over the next three years; this seems about right
Poland: Began hiking October 2021; 665 bp of tightening so far; no more hikes priced in; easing cycle priced to start in Q3; 25 bp of total easing is seen over the next three months followed by another 75 bp over the subsequent three months; policy rate seen bottoming at 3.75% over the next two years; this seems too dovish
South Africa: Began hiking November 2021; 475 bp of tightening so far; no more hikes priced in; easing cycle priced in to start in 2024; no easing seen over the next six months; policy rate seen bottoming at 7.5% over the next two years; this seems too hawkish
Turkey: Began hiking June 2023; 900 bp of tightening so far; 1025 bp of hikes priced in; easing cycle priced to start in 2024; 525 bp of hikes seen over the next three months followed by another 400 bp over the subsequent three months; policy rate seen peaking at 27.75% over the next twelve months, then falling to 22.25% over the next three years; this seems too dovish
ASIA
China: Remains in a gradual easing cycle that began September 2019; 65 bp of easing so far; no change in rates seen over the next six months; tightening cycle priced in to start over the subsequent six months; this seems too hawkish
India: Began hiking May 2022; 250 bp of tightening so far; no more hikes priced in; easing cycle priced to start in 2024; no easing seen over the next six months; policy rate seen at 5.75% over the next three years; this seems too hawkish
Indonesia: Began hiking August 2022; 225 bp of tightening so far; no more hikes priced in; easing cycle priced to start Q4; no easing seen over the next three months and 25 bp over the subsequent three months; policy rate seen at 4.75% by end-2024; this seems about right
Korea: Began hiking August 2021; 300 bp of tightening so far; no more hikes priced in; easing cycle priced to start in 2024; no hikes seen over the next twelve months; policy rate seen at 3.0% over the next three years; this seems too hawkish
Malaysia: Began hiking May 2022; 125 bp of tightening so far; no more hikes priced in; no easing cycle priced in; policy rate seen at 3.0% over the next three years; this seems too hawkish
Philippines: Began hiking May 2022; 425 bp of tightening so far; no more hikes priced in; easing cycle priced to start in 2024; no easing seen over the next six months; policy rate seen bottoming at 4.75% over the next two years; this seems too hawkish
Singapore: Began tightening October 2021; tightened five times so far by adjusting the midpoint and slope of the S$NEER trading band; no more tightening priced in; easing cycle priced to start in 2024; this seems about right
Taiwan: Began hiking March 2022; 75 bp of tightening so far; no more hikes priced in; easing cycle priced to start in 2024; no easing seen over the next six months; policy rate seen bottoming at 1.75% over the next three years; this seems about right
Thailand: Began hiking August 2022; 150 bp of tightening so far; 50 bp more hikes priced in; easing cycle not yet priced in; 50 bp of hikes seen over the next three months followed by steady rates over the subsequent three months; policy rate seen at 2.5% over the next three years; this seems about right
INVESTMENT IMPLICATIONS
Our currency outlooks vary by region. Latin America was the most aggressive in tightening and have been largely successful in squeezing out inflation. This region is best positioned to start easing cycles and the extra carry cushion should allow for sizable rate cuts before their currencies weaken too much. EMEA was the second most aggressive in tightening but fell far short of Latin America. As a result, inflation remains much higher than desired and yet banks are lining up to cut rates. Hungary has already started, with Czech Republic and Poland poised to join it. With much less carry cushion, EMEA currencies are likely to be much more sensitive to narrowing interest rate differentials. Lastly, Asia was the least aggressive in tightening but was able to prevent inflation from rising too much by using subsidies and administered prices to a much greater extent than the other regions. As a result, the market is for the most part not pricing in aggressive easing cycles ahead in Asia but neither do these currencies enjoy a cushion from high carry.
The global backdrop for EM remains negative and so those currencies with weak fundamentals are likely to remain under pressure. Elsewhere, EM currencies with strong fundamentals are likely to suffer if the easing cycles are too aggressive. With EM rates remaining higher for longer, there is much less scope for EM to ease without paying a price. Lastly, while EM easing should help their growth outlooks at the margin, slow global growth (especially China) will be a big headwind for EM.
