US Inflation Unlikely to Pose a Serious Threat to EM

Inflation is likely to remain high in 2021. The primary source of price pressures is the rebound in commodity prices after their sharp collapse last year.

The risk that US inflation spirals out of control cannot be dismissed. Both US fiscal and monetary policy spigots are running fully open, supporting aggregate demand while supply disruptions abound. A prudent Fed would follow the example of many Emerging Markets (EM) central banks and adjust its policy stance. If the Fed opts instead to continue to downplay inflationary risks then the US dollar (USD) is likely to suffer significantly, in our view.

EM countries are in a much more resilient position than in the so-called 2013 ‘Taper Tantrum’ and should not be significantly impacted if the Fed decides to reduce asset purchases and/or signal interest rate increases.

US inflation: still not out of the woods

US consumer price index (CPI) inflation rose to the highest levels since 2008 at a yoy rate of 4.2% in April. The number exceeded consensus expectations and was higher than the most pessimistic analysts’ estimate as surveyed by Bloomberg. However, the increase in commodity prices over the last 12 months already hinted strongly at high inflation. A simple regression of the Refinitiv Core Commodity Index (CRY) on the 3-months lagged US CPI inflation shows that inflation above 4% was extremely likely (Figure 1).

Fig 1: CRY Index vs. 3-months lagged US CPI monthly data regression from Jan-1995