Emerging markets cash in on the Fed's dovish approach

Central banks in emerging economies are easing monetary policy but this window of opportunity may not be open for long

An Indian security guard stands at the entrance of the Reserve Bank of India head office in Mumbai. The RBI has delayed implementing the new accounting rules. AFP

With the Federal Reserve turning more dovish in 2019, one of the main beneficiaries of this shift has been emerging markets (EM).

In the last two weeks, the Reserve Bank of India and the Central Bank of Egypt have both cut interest rates, with other EM central banks also eyeing stimulus moves in the coming months. However, as quickly as this window has opened it may also close, potentially providing EM central banks with only a limited timeframe in which to benefit.

The Reserve Bank of India cut repo rates by 25 basis points to 6.25 per cent and changed its stance to neutral from calibrated tightening. Despite recent falls in inflation (to 2 per cent in January), the cut was a surprise relative to the consensus view but the markets are now coming around to the likelihood that rates are likely to be cut further.

The central bank cut its inflation forecasts for a second successive meeting and now forecasts inflation across the second and third quarters of this year in the range of 3.2 per cent to 3.4 per cent and 3.9 per cent for the fourth quarter. The RBI also flagged concerns over growth including investment slowdown and deceleration in the services sector. With elections looming in May, it seems likely there will be at least another 25bps rate cut in April, and possibly more after that.

Even more of a surprise was the Central Bank of Egypt, which cut its benchmark interest rates by 100bps on February 14 - thereby resuming the rate-cutting cycle, which had been on pause since March 2018. The overnight deposit and lending rates now stand at 15.75 per cent and 16.75 per cent respectively, compared to year-on-year CPI inflation of 12.7 per cent in January. The Monetary Policing Committee justified its cut by reference to incoming data, which "continued to confirm the moderation of underlying inflationary pressures".

Elsewhere in the EM world, other central banks appear to be inching towards easing as well. The Turkish central bank last week cut its reserve requirement ratio (RRR) by 100bps to inject liquidity into the banking sector, while Bank Indonesia also appears to be paving the way for an RRR cut after leaving policy rates unchanged for the third successive month last week. The South African Reserve Bank may not have much room to ease but it may try to resist tightening, as will a number of other central banks from Asia to Latin America.

The rush to ease monetary policy stems from the room provided by the Fed, which is no longer in a hurry to tighten its own monetary policy. How long this will continue for remains uncertain, however. The release of the minutes from the Fed’s January meeting affirmed the central bank’s patient approach to further rate hikes this year. Specifically, policymakers pointed to weak inflation and tightening financial conditions in both the US and other economies as factors in support of keeping rates on hold for now.

According to the minutes, ‘several’ members of the Federal Open Market Committee thought the economy could absorb more rate rises later this year while others specifically needed to see inflation "unexpectedly surge" to support higher rates. With economic data out of the US now starting to show some signs of a slowdown, the prospect of inflation rising unexpectedly does appear more limited.

However, it is too early to conclude that the US rate tightening cycle is completely over. The US economy often slows down at the start of the year only to revive towards the middle of it, and this year had the added complication of a government shutdown which should accentuate this pattern. With the labour market also remaining resilient, it is perhaps no wonder that the minutes were not quite as dovish as the markets had expected. While the EM world may have had a reprieve from the Fed for now, it makes sense for them to take advantage of it sooner rather than later.

Tim Fox is the chief economist and head of research at Emirates NBD