Emerging market central banks are moving toward a more hawkish stance as core inflation rises and energy costs stay high. Citi expects the shift to widen the gap in local bond market returns next year.
Emerging market central banks are pivoting toward a more hawkish stance to combat rising core inflation and sustained high energy costs, according to a Citi research report. Citi says this sets the stage for diverging local bond market returns next year.
Energy costs raise second-round inflation risk
Policymakers are shifting away from dovish and neutral positions as domestic demand and expensive energy inputs push prices up. Citi analysts warned that prolonged high energy costs raise the risk of second-round inflation effects, which central banks must avoid.
However, favorable local currency performance has helped by tightening monetary conditions. Citi has also adjusted its broad dollar assumption toward the weaker side, because segments of the U.S. economy are starting to feel the drag of higher nominal rates. That suggests real effective exchange rate dynamics will not pose major near-term inflation threats for emerging markets.
Central Europe sees tense policy environments
The tightening cycle is creating increasingly tense policy environments in Central Europe, particularly in reflationary Poland and the wage-pressured Czech Republic. Citi expects this dispersion in central bank responses to widen total return dispersion across local bond curves into next year.
Egyptian assets, by contrast, have rallied sharply on broad risk-on sentiment after the U.S. midterm elections. With nominal rates near cyclical highs, Egypt is seeing strong net inflows into front-end tenors. South African government bonds are also outperforming alongside global risk sentiment as local general election results unfold.
Colombia holds, Chile warns, Asia adjusts
In Latin America, Colombia's central bank held its policy rate at 12.25% and unveiled a $2 billion foreign exchange operation alongside the finance ministry. Citi remains underweight on duration for Colombian treasury bonds ahead of a supply jump in October. Meanwhile, Chile's central bank minutes carried fresh hawkish warnings from its board.
Across Asia, Citi tactically added cash overweight positions to five-year, FX-hedged Indonesian government bonds in its portfolio. The bank also flagged re-emerging short-term corporate funding pressures in South Korea. It also evaluated the People's Bank of China's recent hike to its foreign exchange deposit reserve requirement ratio.
Source: Investing.com
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