EM CPI inflation is at multi-year lows at present (top chart), with a clear divergence between world food prices and EM CPI. Food tends to be one of the main components of EM inflation baskets, on average accounting for a 30% weighting. A lot of agricultural commodities have been in multi-year bear markets and have been in a bottoming process (bottom-left chart). A consistent run of good weather and harvests have helped to keep a cap on grain prices, but the risk is that this reverses. The bottom-right chart shows that world food prices are a key driver of EM inflation surprises, offering a short 3-month lead on the Citi EM inflation surprise index.

This is not yet an imminent risk and we continue to like selective EM-DM carry trades. For example in our February monthly report from last week we discussed short EURIDR and EURCOP. However, one of the key risks we are watching is global food prices. Grains appear to be making another attempt to rally and break out at present. After many years of persistently falling food price inflation, a turnaround could be a shock to EM investors after the last two years of large inflows.

(Click on image to enlarge.)

Source: Bloomberg, Macrobond and Variant Perception