A Potential End to Rate Hikes Despite Stubborn Inflation
If deteriorating economic conditions lead to a deep or prolonged cyclical trough, the global monetary policy cycle could pivot, although our baseline expectation is for a prolonged policy pause.
Emerging-market investors are already seeing light at the end of the policy-tightening tunnel. We believe that the tightening cycle is more than 80% complete, with growing evidence that core inflation is decelerating. This means one of the major macro-level headwinds for emerging markets—the tightening of global financial conditions—is abating.
Inflation has been anything but transitory, however, and despite evidence of disinflation, we don’t expect inflation to fall back to pre-pandemic levels in 2023. This could limit central bank maneuverability and might ultimately force central banks to accept higher inflation as a new normal.
China’s Pivot on Zero-COVID Could Bring a Note of Stability
One reason for lackluster emerging-market performance in 2022 was China’s economic underperformance, due in part to lockdowns aimed at staving off the spread of COVID-19 infections. While China’s decision to wind down its zero-COVID policy is encouraging, it isn’t likely to supercharge the growth outlook for emerging markets.
Still, this long-awaited economic reopening, coupled with China’s low commodity inventories, could help stabilize commodity prices and emerging markets as a whole. At the very least, it will remove one of the major obstacles to emerging-market asset prices.
Pockets of Distress Remain, Though Defaults Have Likely Peaked
While we could see an end to rate hikes in early 2023, policymakers aren’t likely to cut rates as quickly as they’ve been able to in previous cycles. The policy pivot might come too late, or the macro downdraft might be too forceful, to avoid distress in the frontier space of emerging markets, where credit stress is high (Display).
