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

Emerging market central banks are adopting a more aggressive approach to tackle rising inflation and high energy costs, according to a report by Citi. This shift from dovish to hawkish policies is expected to affect local bond markets differently next year. Policymakers are abandoning neutral stances as domestic demand and expensive energy inputs drive up prices.

Citi analysts caution that persistent high energy costs could lead to second-round inflation, a situation central banks must avoid at all costs. Favorable local currency performance has assisted these efforts by tightening monetary conditions. With certain sectors of the U.S. economy feeling the impact of higher nominal rates, Citi has revised its dollar outlook to be weaker, indicating that exchange rate dynamics will not pose significant near-term inflation risks for emerging markets.

This tightening cycle is creating tense policy environments in Central Europe, especially for inflation-prone Poland and the Czech Republic. Citi anticipates that the varying responses from central banks will widen the total return dispersion across local bond curves in the coming year. Meanwhile, Egyptian assets have gained significantly due to risk-on sentiment following the U.S. midterm elections.

With nominal rates near cyclical peaks, Egypt is attracting substantial net inflows into short-term bonds. South African government bonds are also benefiting from broader risk sentiment as local general election results are announced. In Latin America, Colombia's central bank maintained its policy rate at 12.25% and announced a $2 billion foreign exchange operation.

The bank remains cautious about duration in Colombian treasury bonds (COLTES) ahead of a supply increase in October. Chile's central bank has issued hawkish warnings from its board, keeping the peso long against the U.S. dollar. In Asia, Citi has increased exposure to five-year, FX-hedged Indonesian bonds and highlighted rising short-term corporate funding pressures in South Korea, as well as the People's Bank of China's recent increase in its foreign exchange deposit reserve requirement ratio.