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Early moving EM central banks caught in Fed inflation crossfire

Velarde, Julio-70.jpg

EM central bank governors may have no choice but to keep raising rates — despite the cost to economic activity and having earlier acted decisively on inflation

As IMF managing director Kristalina Georgieva this week reiterated her call for central banks to stay the course with rate hikes, emerging market countries that largely acted far more decisively to combat inflation than their developed market counterparts are in a squeeze as rich countries play catch up.

US inflation yet again came in above target this week, with September CPI recorded at 8.2%.

“With yesterday’s inflation number, the US will raise rates again, and this will generate difficulties in facing debt maturities in middle-income countries,” said Sergio Masa, Argentina’s economy minister at an Atlantic Council event in Washington DC on Friday. Many of these countries are “on the way to ending up without access to capital markets”, said Masa.

According to Tellimer Research, almost 40% of countries in EM sovereign dollar bond indices are offering yields of over 10% — making fundraising extremely hard — and there have been several warnings this week about refinancing and default risks as borrowing costs have increased.

The end of the ‘Fed put’ — or the growing consensus that the Federal Reserve will not ease policy to support markets when turmoil hits — means markets will “remain at the mercy of US inflation prints”, Edward Glossop, EM economist at UK-based investment manager Abrdn, told GlobalMarkets.

“The news this week on this front was not particularly pretty,” said Glossop, continuing the “challenging backdrop for EM”.


In a bind

Yet even countries that are a long way from debt distress are facing acute uncertainty. Many EM central banks are seasoned inflation fighters, and Latin American policymakers, in particular, moved faster than the rest of the world to tighten policy. Yet the strong dollar and high interest rates are taking matters out of their hands.

Julio Velarde, Peru’s central bank governor, told GlobalMarkets that he hoped the country was near the end of its own policy tightening cycle, and that he expects inflation to return to 3% by the end of 2023. But he said it would be a “bumpy ride” — and very uncertain.

“Nobody can tell for sure what is going to happen,” he said, referring to both potential unknown inflationary surprises and the Fed’s actions. Although US rates are already expected to peak at 4.5%-4.75% next year, “inflation remains ingrained”, said Velarde.

“Probably it [the Fed] has to be more aggressive. So who knows? There's a lot of uncertainty.”

Developed markets took “too long” to realise what was going on, Marcelo Carvalho, BNP Paribas’ chief economist, told GlobalMarkets this week. “The later you start, the more you have to lose,” he said, and the downturn in growth coupled with inflation that will remain above target is going to signify a “very challenging period for central banks”.

“They’re going to be facing increasing political pressure to do ‘whatever it takes’,” said Carvalho. “There will be people saying that rate rises are overkill, but I think central banks just have to act — otherwise we’re facing inflation that will be larger for longer.”

Jamaica, one of the countries that began to raise rates long before the Fed, has increased its policy rate by 600bp in this cycle — triggering public calls from MPs, private sector organisations, and manufacturers and exporters to halt rate rises. The central bank is aware of its impact, but has little choice but to be “very careful with the Fed”, said Richard Byles, governor of the Bank of Jamaica.