No easing of rates outside US: Citigroup

ANALYSTS' VIEW

Tightening financial conditions have set the stage for early Fed easing. Outside the US, there is no longer expectation of the ECB, BoJ, BoE, and BoC to hike rates this year again. The market crisis is unlikely to prompt early easing outside of the US, unless financial conditions deteriorate markedly further.

"We expect foreign currency carry trades in Japan and Switzerland to unwind further on heightened risk aversion and expect risk premium on other assets to remain elevated compared to levels of a month ago," according to the Citigroup report.

Uncertainties have surged (as a result of the fallouts of sub-prime crisis). A variety of emerging market countries may also delay or reverse rate hikes. In addition, there are expectation of greater near-term yen strength, but more extended dollar weakness in 2008.

The extraordinary uncertainty and disruptions in financial markets mean that further changes in the policy and market outlook could prove large and abrupt, even over the very near term.

Emerging market growth and prospects remain generally solid. In recent months, consensus forecasts have continued to rise for emerging market growth in Eastern Europe, Asia, and Latin America. Even so, forecasts for those regions remain above consensus.

Moreover, improved current account positions, ongoing FDI inflows, shrinking external debts, high forex reserves, plus better monetary and fiscal positions (in aggregate) have greatly reduced the vulnerability of many emerging markets to "sudden stops," triggered by the US slowdowns or credit market distress.

However, not all countries are in the same position. Those most leveraged to the US growth, facing external imbalances or with little scope to adjust policy due to inflation or fiscal pressures, will see economic and market performance suffer more than average.

With generally robust conditions, though, emerging market spreads have widened fairly modestly relative to previous episodes of market turmoil, and remain low by historical norms.

In turn, the lack of severe financial market stress has allowed emerging market monetary policies to remain focused on medium-term inflation and economic-stability goals.

As with the industrial countries, the central banks that are still expected to tighten and will do so because growth is strong and as a precautionary move against future inflation risks, rather than in response to currency or funding crises.

Under these conditions, there are expectations of strong growth and/ or overheating to trigger further tightening in China, Poland, the Czech Republic, Colombia, and Argentina (among others). But there are scope for some easing in Brazil, Mexico, Turkey, Hungary, Russia, Hong Kong, Indonesia, and the Philippines.

Moreover, with improved fiscal positions in recent years, fiscal policy remains a viable tool for stimulus (if needed) for many emerging market countries. Overall, higher risk premiums are likely to produce more varied economic and market outcomes in emerging markets.