Central banks hit ‘pause’

Dünya Executive - - REPORT - Andreas Kolbe, strateg st, Barclays

Central banks in emerging markets are under less pressure to tighten, after the dovish stance from the Federal Reserve translated into generally stronger EM assets over the past few weeks. Downside risks to growth and uncertaint­y regarding trade are probably the main concerns for EM central bankers, as inflation pressures are not yet evident. Overall EM inflation decelerate­d from 3.1 percent year-on-year in Q3 2018, to 2.9 percent in Q4 2018. More granularly, we forecast that Q1’s 2019 inflation will decelerate in Latin America and Asia, while slightly accelerati­ng in emerging Europe, driven mostly by Poland and Russia. Then, we expect overall EM inflation to stabilize. In contrast, we still see downside risks to growth, particular­ly if trade talks between China and the U.S. do not lead to an immediate solution, and risks of a trade war with further tariff increases intensify again. With the Fed’s concerns (temporaril­y) out of the way, EM central banks may tilt to a more dovish stance and see solid YTD EM asset returns. A natural question is if the markets have entered another ‘goldilocks’ period. We do not think this is the case, and we expect that the market focus is likely to shift to other risk factors that could derail sentiment; including global activity slowdown, trade negotiatio­ns and political events. Moderating economic activity outside of the U.S., especially in Europe and China, is likely to warrant some caution from investors and prevent indiscrimi­nate allocation in emerging markets and risk assets. In our view, the alleviatio­n in global borrowing rates favours high carry versus low carry in EM local markets, and current account deficit economies with high betas to U.S. rates over export-dependent ones. In foreign exchange, we recommend a short euro versus a basket of South African rand, Turkish lira, and Brazilian real. We widen our target and stop-loss, as momentum might moderate and volatility could increase nearterm on the trade front. However, some caution is warranted, as we expect north Asia and CEE FX to underperfo­rm in relative terms. (February 7)

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