Emerging market central banks turn hawkish as inflation pressures mount, Citi says

 Emerging market central banks are pivoting toward a more hawkish stance to combat rising core inflation and sustained high energy costs, setting the stage for diverging local bond market returns next year, according to a research report from Citi.

Policymakers are shifting away from dovish and neutral positions as domestic demand and expensive energy inputs apply upside price pressure. Citi analysts warned that prolonged high energy costs elevate the risk of second-round inflation effects - a scenario central banks must avoid "at all costs."

Favorable local currency performance has aided these efforts by tightening monetary conditions. With segments of the U.S. economy beginning to feel the drag of higher nominal rates, Citi has adjusted its broad dollar assumption toward the weaker side, suggesting real effective exchange rate dynamics will not pose major near-term inflation threats for emerging markets.

Regional pressures and rallies

The tightening cycle is creating increasingly tense policy environments in Central Europe, particularly for reflationary Poland and the wage-pressured Czech Republic. Citi expects this dispersion in central bank responses to widen the total return dispersion across local bond curves into next year.

Conversely, Egyptian assets have rallied sharply on broad risk-on sentiment following the U.S. midterm elections. With nominal rates near cyclical highs, the country is seeing strong net inflows into front-end tenors. South African government bonds are also outperforming alongside global risk sentiment as local general election results unfold.

In Latin America, Colombia’s central bank held its policy rate at 12.25% while simultaneously unveiling a $2 billion foreign exchange operation alongside the finance ministry. The bank remains underweight on duration for Colombian treasury bonds (COLTES) ahead of a supply jump in October. Meanwhile, Chile’s central bank minutes delivered fresh hawkish warnings from its board, keeping investor positioning long on the U.S. dollar against the Chilean peso.

In Asia, Citi tactically added cash overweight positions to five-year, FX-hedged Indonesian government bonds in its portfolio. The bank also flagged re-emerging short-term corporate funding pressures in South Korea and evaluated the People’s Bank of China’s recent hike to its foreign exchange deposit reserve requirement ratio.