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Disinflation Successes – What’s Next?

December 09, 2022

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Brazil’s disinflation is a major success – so why the market thinks that room for rate near-term rate cuts is now more limited?

LATAM Policy

Brazil is the world’s #1 disinflation success story. Annual headline inflation dropped from 12.13% April peak to less than 6% in November, and the Bloomberg consensus expects Brazil to be the first major emerging market (EM) - other than China - to bring inflation back to the target range (in Q1-2023). Brazil also has by far the highest ex-ante real policy rate in EM (north of 8%, when adjusted by expected inflation). So, why the local swap curve pushed the first rate-hike from March/May 2023 to September/November 2023 after the presidential elections runoff? The reason is that the market (and the central bank) are concerned about fiscal risks under new administration – check today’s reports about appointing Fernando Haddad (leftist) as Brazil’s new Minister of Finance.

China Reopening

China’s headline inflation is already below the target – and it moderated even more in November (to 1.6% year-on-year – see chart below). The key reason is soft domestic demand and the prevalence of the supply side stimulus. Authorities started to address the former a bit more aggressively lately – including a sizable support package for property developers and frequent tweaks in the zero-COVID policy. If these policy shifts are successful, inflation would be expected to go up, potentially leading to some policy tightening in 2023. In the near term, we keep an eye on the next batch of China’s credit aggregates – they should be out any day now – the consensus expects to see a big increase both in aggregate financing and new yuan loans. 

Fed Policy Pivot

EM disinflation is great, but the global markets are fixated on the U.S. price trends, which will determine the timing of the Federal Reserve’s policy pivot. And today’s University of Michigan survey provided some food for thought. Both the current conditions and the expectations components were stronger than expected, but there were no changes in the very long-term inflation expectations (3%), whereas short-term (1-year) expectations dropped from 4.9% to 4.6%. This looks consistent with the near-term rate expectations embedded in Fed Funds Futures – more tightening but at a slower speed, including +50bps next week. However, there are still questions about policy room for Fed rate cuts in H2-2023. Stay tuned!

Chart at a Glance: China Inflation – Time to Turn?

Chart at a Glance: China Inflation - Time to Turn?

Source: Bloomberg LP.

PMI – Purchasing Managers’ Index: economic indicators derived from monthly surveys of private sector companies. A reading above 50 indicates expansion, and a reading below 50 indicates contraction; ISM – Institute for Supply Management PMI: ISM releases an index based on more than 400 purchasing and supply managers surveys; both in the manufacturing and non-manufacturing industries; CPI – Consumer Price Index: an index of the variation in prices paid by typical consumers for retail goods and other items; PPI – Producer Price Index: a family of indexes that measures the average change in selling prices received by domestic producers of goods and services over time; PCE inflation – Personal Consumption Expenditures Price Index: one measure of U.S. inflation, tracking the change in prices of goods and services purchased by consumers throughout the economy; MSCI – Morgan Stanley Capital International: an American provider of equity, fixed income, hedge fund stock market indexes, and equity portfolio analysis tools; VIX – CBOE Volatility Index: an index created by the Chicago Board Options Exchange (CBOE), which shows the market's expectation of 30-day volatility. It is constructed using the implied volatilities on S&P 500 index options.; GBI-EM – JP Morgan’s Government Bond Index – Emerging Markets: comprehensive emerging market debt benchmarks that track local currency bonds issued by Emerging market governments; EMBI – JP Morgan’s Emerging Market Bond Index: JP Morgan's index of dollar-denominated sovereign bonds issued by a selection of emerging market countries; EMBIG - JP Morgan’s Emerging Market Bond Index Global: tracks total returns for traded external debt instruments in emerging markets.

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