London
MAJOR emerging markets are set to report a slowdown in inflation this week, offering clues on when investors can finally shake off the burden of negative real yields.
After Egypt kicked off the week by reporting a monthly contraction in consumer prices, 15 other developing nations were set to release their own readings. Of them, all but 2 have inflation-adjusted policy rates below 0. It is a feature of the pandemic era as supply chain disruptions and worker shortages drove prices higher, and a phenomenon that has dimmed the appeal of emerging-market assets.
Central banks from Russia to Brazil have responded with rate hikes of several hundred basis points in the past year, and this week will reveal whether their gamble of prioritising inflation control over growth is starting to pay off. If it does, it would validate bets by money managers from Vontobel Asset Management to BNP Paribas Asset Management, who prefer local-currency debt on expectations that inflation will moderate in the second half of this year. If it does not, emerging markets could become even more unloved in an era of rising US yields.
"Many investors will look for evidence of a peak in inflation, or a turn in central-bank behaviour, before investing in local bond markets," said Paul Greer, a money manager at Fidelity International. "We expect negative real rates in many emerging markets to flip to positive territory towards the middle of the year, primarily driven by inflation pressures cooling rather than additional aggressive policy tightening."
Pervasive negative real yields in emerging economies are a rare occurrence, brought on in the past year by economic challenges related to Covid-19. Governments and central banks that eased financial conditions to help their impoverished populations survive lockdowns were caught out by a surge in prices. Of the 43 developing nations tracked by Bloomberg, 35 offer negative rates. Prior to Covid, 32 of 42 countries tracked provided positive returns.
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Aggressive response
Some emerging economies are no strangers to negative yields. In eastern Europe, inflation-adjusted policy rates have been below 0 for years, and the post-pandemic economy has only deepened the gulf. Real rates are minus 6.35 per cent in Poland and minus 2.25 per cent in the Czech Republic. In Hungary, 7 successive rate hikes have still left the real rate far below 0.
"For some of the most hawkish central banks in the region, for example the Czech Republic, the main driver will be inflation starting to fall as opposed to a further large increase of policy rates in 2022," said Claudia Calich, the head of emerging-market debt at M&G Investments.
Negative real rates ensnared even the higher-yielding regions of emerging markets, such as Latin America and Africa. But unlike developed markets, emerging economies spent no time debating whether inflation was transitory and opted to raise rates even in the midst of crippling lockdowns. Russia and Brazil were among the most hawkish, raising their benchmark borrowing costs by 425 and 725 basis points, respectively, in 2021.
Little time
Early signs are encouraging. Russia's real rate rose to just above 0 last month. Consumer-price growth is projected to slow in Brazil, China, Nigeria and Hungary. But other nations including India and the Czech Republic are still expected to grapple with accelerating inflation.
Time is of the essence: US Federal Reserve tightening is around the corner. Minutes from its December meeting indicated a faster rates lift-off and balance sheet contraction. The first hike could come as early as March, St Louis Fed president James Bullard said last week.
If real policy rates do not turn positive by then, emerging markets could see an investor exodus that could exacerbate local-currency bonds' worst annual loss in 6 years in dollar terms. For Charlie Robertson, global chief economist at Renaissance Capital, the first movers against inflation will be the eventual victors in the battle against negative real yields.
"Some emerging-market central banks reacted faster and more significantly than developed markets, and we expect them to be rewarded with much slower inflation by year-end," he said.
Here are some of the main economic data releases to watch: Brazil's IPCA inflation measure is expected to have moderated in December to just above 10 per cent. The respite in fuel prices will probably result in a slower monthly rate, which will help offset a likely acceleration in food prices, said Bloomberg Economics.
China's consumer price inflation likely dropped back below 2 per cent last month and factory-gate prices are expected to have cooled. Food prices likely started to drag down inflation again, while the government's efforts to increase energy supply and stabilise prices probably helped ease producer prices, Bloomberg economists wrote.
India's inflation likely surged back close to the central bank's target ceiling in December. Economists cite a lower base from a drop in food prices a year earlier as one technical factor, though signs of strengthening underlying inflationary pressures are emerging.
Russia's core consumer price index is estimated to have accelerated to more than 9 per cent year on year last month, which would be the fastest pace in nearly 6 years. Final figures for headline inflation, estimated at 8.4 per cent, are also due. BLOOMBERG
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