Emerging market easing cycle likely to continue: UBS By Investing.com

Investing.com — The global monetary policy landscape is changing, with emerging market (EM) central banks taking the lead in both tightening and easing cycles. Unlike previous financial cycles, where advanced economies dictated global policy, countries such as Brazil, Hungary and Chile proactively adjusted their monetary policies ahead of major central banks.

According to UBS Global Research analysts in a note dated Tuesday, the easing cycle in these emerging markets is expected to continue, albeit cautiously, as central banks navigate domestic and global economic factors.

The current global monetary policy cycle is unique in its configuration. Emerging market central banks started tightening policies earlier than their developed market counterparts, primarily due to inflationary pressures and currency volatility.

This early action has now moved into a phase of gradual easing in several EM economies, which UBS analysts expect to continue. “Emerging market central banks appear to be doing just that – slowing down and reassessing, giving them time to consider the impact of unexpected bumps along the way,” the analysts said.

The easing is partly driven by a desire to boost economic growth, which has shown signs of resilience but remains below expectations in some regions.

UBS Global Research reports that emerging market central banks are increasingly taking a cautious approach as they move deeper into their easing cycles. This strategy echoes the analogy used by Federal Reserve Chairman Jerome Powell, likening the economy to a car approaching its destination: As one nears the exit, it is prudent to start slowing down rather than waiting until the last moment to brake.

Similarly, as EM central banks approach their inflation and growth targets, they are slowing the pace of rate cuts to better assess the economic impact and make the necessary adjustments.

This careful approach is crucial in light of the economic volatility experienced in August, when financial markets, including currency valuations, were temporarily disrupted. Such fluctuations have the potential to influence inflationary expectations in emerging markets, requiring a more measured pace of monetary easing.

UBS analysts note that while there is a general easing trend, disinflation in some emerging markets has been interrupted by idiosyncratic factors. In Mexico and Chile, for example, volatile prices for fresh fruits and vegetables, exacerbated by extreme weather conditions, temporarily disrupted the downward trend in inflation.

In addition, regulated electricity tariffs have increased in some cases, further complicating the trajectory of disinflation. These factors signal the need for a cautious approach to monetary policy, as premature or overly aggressive easing could undermine progress in stabilizing inflation.

“We estimate that most emerging market currencies will trade sideways to moderately stronger against the US dollar in the coming quarters,” the analysts said.

The US dollar remains overvalued by various metrics, and its sustainability depends on a continued inflow of foreign capital to finance its large current account and fiscal deficits. As the Fed potentially begins its own easing cycle, the relative attractiveness of emerging market assets may increase, providing support to EM currencies.

Brazil is an outlier in the emerging market landscape, as UBS analysts anticipate a different trajectory for monetary policy. The country is expected to raise interest rates significantly in the coming months, a move driven primarily by its unique fiscal policy choices rather than a broader trend in Latin America or other emerging markets.

The Brazilian real is also expected to trade sideways to modestly higher against the US dollar, reflecting the market’s response to Brazil’s distinct fiscal and monetary environment.