EM central banks waiting for Fed

Average headline inflation remained subdued in August, moving slightly higher to 4.6% YoY from 4.5% average in July. This brings average inflation for 3Q to 4.6%, down from 4.7% in 2Q. Core inflation also remained contained and stabilized at 4.1% in August, the same print as in July. 

"We revised down our forecasts for CEE, Nigeria, India and Korea. We increased our forecast for China. We expect a mild pick-up in inflation in 4Q, mainly due to base effects, as the commodity collapse started at the beginning of 3Q14", says BofA Merrill Lynch.

The market also moved after the Fed. For example, in Mexico and South Africa, the market now prices only one hike for the rest of 2015 while two were previously expected. The next hike by Banxico and the SARB will not happen until 1Q16. In Colombia, two hikes are priced in, given very sluggish growth and contained inflation. In Malaysia, the market pushed back the priced-in hike date from 4Q15 to 1Q16. BNM is expected to keep the policy rate unchanged at 3.25% through 2016. 

In Brazil, inflation and inflation expectations are likely to trend down, and forecast Bacen would cut the Selic 275bp in the next 12 months. However, there is significant uncertainty given substantial BRL depreciation, which may eventually push inflation up. In Russia, 250bp in cumulative cuts through 1H16 is expected. However, cuts could be postponed in the event of persistent market volatility. 

"We expect much softer cuts in China and India, including only one 25bp cut to the policy rate in 2015. For India, we also expect a 25bp cut in India in 1Q16", notes BofA Merrill Lynch.

Slopes of Treasury and EM curves have remained stable in September. In EM, this follows two months of sharp flattening. From this point on, EM slopes are expected to be dominated by two opposing effects. On one hand, gradual tightening in the US and a flattening of the UST curve should flatten EM curves. On the other hand, looser EM monetary policy relative to the US could lead to curve steepening. By contrast, in small open economies such as Chile, Colombia, Czech Republic and Israel, foreign rates play a more significant role.