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The market’s focus today, of course, is on the US inflation, which surprised slightly to the downside – possibly due to the Delta resurgence - we’ll see whether this argument holds after the next release. One important indicator to watch is the dispersion of US inflation – specifically the fraction of items with price increases in the inflation basket. This fraction rose to 84.3% in June from 66.7% in December, so make sure to check the next update (from the San Francisco Federal Reserve). In the meantime, one thing that attracted our attention on the inflation front is an unusually wide gap between inflation surprises in emerging markets (EM) and developed markets (DM) (see chart below).
The first thing that comes to mind is that central banks in EMEA and LATAM had been tightening for several months now – the average policy rate went up by about 170 basis points (bps) since February in both regions – and this started to have an impact on prices, and surprises. The next important rate-setting decision will be in Brazil on September 22. The market and consensus expect a larger hike (115-125bps), but Governor Campos Neto’s latest remarks, about sticking to a longer-term plan of actions, suggest that the central bank might opt for 100bps instead.
It is also worth mentioning that the proliferation of orthodox, that is more credible, monetary policies in EM after the global financial crisis of 2008 reduced the passthrough between FX and inflation in many countries. As a result, EM FX weakness is not adding to upside inflation surprises the way it used to do in the past. Finally, another possible explanation for the large discrepancy between EM and DM inflation surprises is that certain EM geographies continue to rely on lockdowns in order to control the virus outbreaks. However, the pace of daily vaccinations in EM is increasing, pointing to a stronger rebound in domestic demand, and a potential catch up with DM inflation surprises, later on. So, stay tuned!
Source: Bloomberg LP