Inflation Drumbeat: Emerging Markets in 2021

EM inflation drumbeat is not yet very strong, despite local risks and the louder chatter in DM. Brazil’s industrial production is recovering, but the pace of the emergency aid withdrawal will be key in many respects.

Inflation is one of today’s big stories, supported by renewed hopes for the U.S. stimulus (especially after the weak labor report), rising market-based inflation expectations in Developed Markets (DM) (see chart below), and the chatter about higher oil prices. In our part of the world (Emerging Markets [EM]), the inflation landscape is still very mixed. Some countries are clearly “re-heating” – Russia, Turkey, Chile, and the Philippines. However, lower headline inflation in Poland and Mexico re-opened conversations about rate cuts. Poland’s rate-setting meeting is next week, and it will be closely watched. One argument against a rate cut is the fact that the policy rate is already very low (0.1%), so the central bank might opt for dovish guidance and another round of FX interventions instead.

Brazil’s industrial production looked nice and comfy, with another positive annual growth rate in November (2.8%). A big question on everybody’s mind right now is how the government will handle the withdrawal of the emergency aid. This will have material implications both for domestic activity and the sovereign credit metric. Uncertainty on fiscal issues (including the spending cap rule) spooked the bond market on more than one occasion in 2020 – and this explains why the market pays so much attention to the election of the new Lower House Speaker.

Mexico’s administrative reform – especially the proposed elimination of autonomous bodies – is back in headlines. While the new is not actually “new”, this reinforces the market concerns about the quality of Mexico’s institutions. Some commentators actually suggest that these risks can force the central bank to reject rate cuts, despite a slightly more benign inflation backdrop.