While regions like LATAM and EMEA are still in a disinflationary phase, Asia's negative inflation surprises have ended. It's now experiencing small upside surprises, suggesting its monetary policy will diverge, with central banks remaining on hold, contrary to easing trends elsewhere.
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In 2026, major central banks will diverge significantly. The U.S. Fed and ECB are expected to cut rates in response to slowing growth and disinflation. In stark contrast, the Bank of Japan is poised to hike rates as it finally achieves reflation, making it the sole hawkish outlier among developed market central banks.
Emerging market monetary policy is diverging significantly. Markets now price in rate hikes for low-yielding countries like Colombia, Korea, and Czechia due to stalled disinflation. In contrast, high-yielding markets continue to offer attractive yield compression opportunities, representing the primary focus for investors in the space.
The firm's analysts anticipate persistent core inflation in select emerging markets, suggesting an end to easing cycles. This contrasts sharply with clients who expect further disinflation driven by pressures from China and energy prices, marking a key area of disagreement on the global economic outlook.
In a stark regional divergence, Japan is tightening its monetary policy while its Asian peers are easing. The Bank of Japan has raised rates to a 30-year high, and its government bond yields have surpassed China's. This counter-cyclical stance makes Japan a significant outlier in the Asia-Pacific economic landscape.
Viewing Asian FX as a single bloc is a mistake. Markets are driven by distinct, country-specific events, such as MSCI reclassification concerns in Indonesia, equity outflows in India, and the central bank's stance on an overvalued currency in Thailand.
In a significant role reversal, emerging market central banks were more proactive and aggressive in tightening monetary policy to combat post-COVID inflation than developed market institutions. This action demonstrates a secular improvement in their credibility and sovereign credit quality.
Despite Japan breaking its deflationary cycle, the Bank of Japan is hesitant to raise rates. The current inflation is primarily attributed to a weak yen and supply-side factors like energy costs, not robust consumer demand. With real consumption still below pre-COVID levels, the central bank remains cautious.
Despite strong export-led growth in Asia, the benefits did not trickle down to households. Weak household income and consumption prompted governments and central banks to implement fiscal support and monetary easing. This disconnect between headline GDP and domestic demand is a critical factor for understanding Asian economic policy.
A significant split in monetary policy is expected in 2026. The US Federal Reserve and European Central Bank are predicted to cut rates in response to slowing growth and easing inflation. In stark contrast, the Bank of Japan is on a hiking cycle, aiming to reflate its economy.
The disinflationary impact from goods prices has largely run its course in emerging markets. The remaining inflation is concentrated in the service sector, which is sticky and less responsive to monetary policy. This structural shift means the broad rate-cutting cycle is nearing its end, as central banks have limited tools to address services inflation.