Investing.com -- The global monetary policy landscape is seeing a shift, with emerging market (EM) central banks taking the lead in both tightening and easing cycles. Unlike in previous financial cycles, where advanced economies dictated global policy, countries like Brazil, Hungary, and Chile have proactively adjusted their monetary policies ahead of major central banks.
As per analysts UBS Global Research 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 began tightening their policies earlier than their counterparts in developed markets, primarily due to inflationary pressures and currency volatility.
This early action has now transitioned into a gradual easing phase in several EM economies, which UBS analysts predict will continue. “Emerging market central banks appear to be doing just that—slowing down and reassessing, giving them time to consider the impact of some unexpected bumps along the way,” the analysts said.
The easing is partially motivated by the desire to stimulate economic growth, which has shown signs of resilience but remains below expectations in some regions.
UBS Global Research flags that emerging market central banks are increasingly adopting a cautious approach as they move deeper into their easing cycles. This strategy echoes the analogy used by Federal Reserve Chair 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 to make necessary adjustments.
This careful approach is crucial in light of the economic volatility experienced in August, where financial markets, including currency valuations, were temporarily disrupted. Such fluctuations have the potential to influence inflation expectations in emerging markets, necessitating a more measured pace of monetary easing.
UBS analysts note that while there is a general trend toward easing, disinflation in some emerging markets has been interrupted by idiosyncratic factors. In Mexico and Chile, for example, volatile prices of fresh fruits and vegetables, exacerbated by extreme weather conditions, have temporarily disrupted the downward trend in inflation.
Additionally, regulated electricity tariffs have risen in some cases, further complicating the disinflation trajectory. These factors flag the need for a cautious approach to monetary policy, as premature or overly aggressive easing could undermine the progress made in stabilizing inflation.
“We anticipate that most emerging market currencies will trade sideways to moderately stronger against the US dollar in the coming quarters,” the analysts said.
The U.S. dollar remains overvalued according to various metrics, and its sustainability depends on a continuous influx 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 exception in the emerging market landscape, as UBS analysts anticipate a different monetary policy trajectory. The country is expected to increase interest rates significantly in the coming months, a move primarily driven 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 stronger against the U.S. dollar, reflecting the market’s response to Brazil’s distinct fiscal and monetary environment.