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Emerging Issues
Short-Term Gain, Longer-Term Pain?
Policy headwinds to EM growth set to ease: China’s latest rate hike and likely its last for 2011 is, in our view, reflective of an end to the policy headwinds to growth across much of the EM world. Most central banks are keen to take their policy stance towards neutral as growth slows to trend and inflation moderates. This sets the stage very nicely for a return to risky assets.
EMflation: Dead or alive? However, we believe that the rumours of the death of EMflation are premature. Quantitative tightening aside, monetary accommodation via low real policy rates and loose fiscal conditions imply upside risks to domestic demand. A better 2H performance from the US implies upside risks to external growth. Overall, the risks to EM inflation in 2012 remain to the upside. To boot, structural forces playing out in the background also create inflationary pressures for EM.
Core inflation in the spotlight: While EMflation in 2011 was all about commodity price inflation, the 2012 variety is likely to show up as higher core inflation. Core inflation is already high in India, Korea, Brazil and Russia and at a near-decade high in China but at low levels.
Another round of rate hikes? Central banks are likely to follow up rising core inflation with another round of rate hikes, this time without kicking the EMflation can down the road. For now, there is a period of calm to be enjoyed.
Not time to pay rates yet; better to go long breakevens or choose linkers over nominal bonds
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