Ending months of speculation, the US Federal Reserve decided to hold interest rates at their historic low levels last week, as concerns for a fragile global economy overshadowed recent evidence of a strengthening US recovery.
Janet Yellen, the Fed chair, stressed that growth in emerging markets was an important consideration behind the decision to keep US interest rates on hold. Forecasts from the Fed’s board members had suggested that the first increase in nine years would take place this year, but three officials now expect Yellen to hold off until 2016, and one predicted it may even be 2017 before rates rise.
Institutional investors and analysts have already begun to speculate regarding the impact of the decision on emerging market investment strategies. In today’s blog, we have summarised some of these reactions.
As a refresher, here is an updated emerging market performance/valuation map
“In our view as investors in emerging markets, this isn’t necessarily positive news, because we are still left with the uncertainty that has been plaguing the market for some time. We know that the markets dislike uncertainty, so we could also be left with continued volatility through year-end.
On the other side of this equation are the positive aspects. If in coming months the Fed feels confident enough in the US economy to raise interest rates, it could be viewed as positive news for emerging markets, particularly those with export ties that benefit from a strengthening US economy. We would anticipate a stronger US economy would likely bring increased demand for more imported goods, and a stronger US dollar relative to other emerging market currencies could put emerging markets in a more favorable trade position. Weaker currencies tend to promote exports and help manufacturers.”
J.P. Morgan Asset Management
“Regardless of economic impacts, the Fed’s rationale for its decision does suggest a slower general increase in interest rates, limiting bond market losses and potentially producing gains in some areas. It could also boost emerging market assets if investors feel less urgency to move money ahead of a more general flow of capital to the United States. Finally, it could limit U.S. equity market gains. While the Fed cited volatility as one of its reasons for not raising rates at this meeting, increased uncertainty about the Fed will likely increase volatility and thus hurt U.S. stocks even as the Fed itself, satisfied with U.S. progress, nevertheless waits on the world to change.”
Recent related piece from Gabriela Santos Global and Ben Luk from Global Market Strategy team titled Emerging markets and the Fed: A game changer?
Fidelity Management & Research
“The market was not expecting a rate hike, so this outcome is exactly what was priced in. So while there is often a lot of noise immediately following a Fed announcement, there shouldn’t be a lot of market movement in the short term. Long-term, conditions haven’t really changed. The United States remains the best house in a bad neighborhood—domestic economic progress is better than in most other developed countries. With slow growth, a low rate environment may persist for longer than many investors were anticipating. If the Fed does move to tighten in the near term, it’s going to squeeze dollar liquidity even more. In my view, that could potentially be an even bigger headwind for some areas, like China and emerging markets, which have already been hit the hardest. So, my expectation going forward is that the market volatility we’re seeing is going to remain relatively elevated.”
Recent related piece from Dominic Rossi (Global Chief Investment Officer, Equities, at Fidelity Worldwide Investment): FT: World faces third deflationary wave – EM crisis means further fall in potential global output is unavoidable
“As external factors are outweighing domestic it could be argued that the outlook for the Fed now depends on the outlook for China. In our view China may get a boost from fiscal support in the coming months, but the underlying picture is one of an economy where growth is grinding lower. The Fed could well wait beyond January before lift-off with March 2016 now the more likely date. All in all, the Fed’s economic outlook remains relatively stable and positive. However, it is clear that international developments will dominate Fed policy in the near-term.”
Deutsche Asset & Wealth Management
“While the Chinese backdrop is not encouraging, the U.S. domestic economy continues to do well and the Eurozone is getting back on its feet, meaning that any developed-market correction is likely to be short-term in nature. Emerging markets may find the going tougher. Aggregate EM economic growth remains strong but there does appear to be an underlying trend towards slower export growth, even after the recent currency depreciation. A structural shift towards consumption in many emerging markets may be one reason for this. Another could be the increasing economic complexity of Asian economies, meaning that they can handle more aspects of the production process internally with less need for foreign trade of inputs.”
UBS Asset Management
“It now looks likely that the Fed will hike in December, despite Chair Yellen’s insistence that the October meeting is still ‘live’. It is often argued that the Fed will only start its rate hikes when it has a press conference to explain, but there are procedures to call an ad hoc press conference after any meeting so that is not really a limitation. What is a limitation is that the “global economic and financial developments” are unlikely to be resolved enough in the next six weeks for the Fed to feel more confident.”
HSBC Asset Management
“EM equities are attractive for western currency based investors (USD, GBP or euro based) in our view. Within EM, Asia is our preferred region, as the prospective returns look higher, supported by the potential for currency upside over the long term, though there could be some volatility in the near term with Fed tightening approaching and a slowdown in China. We continue to believe that the global economic recovery is on track and global equity markets will post positive returns over the long term. In our opinion, continued support from global quantitative easing (QE) will, in the medium and longer term, likely outweigh headwinds created by slower Chinese growth and tighter US monetary policy.”
Lazard Asset Management
“We have taken advantage of the recent volatility to allocate capital to companies that we view as being punished in disproportion to their actual cash flow at risk. Having deep bottom-up fundamental research and clearly defined scenarios for company earnings and valuation can turn situations like these into excellent buying opportunities.
The China slowdown is to some degree inevitable as the law of large numbers and competitive pressures arising from wage increases and environmental degradation affect growth. Many companies have adapted to a range of economic changes in the last decade and will do so in this situation. Valuations are not stretched, especially after the recent sell-off, although they are above historical levels. When compared to fixed income alternatives, equities look inexpensive on many counts. Our view is that the near-panic seen in recent days in various markets could represent a capitulation that creates opportunities for investors with time horizons measured in years rather than months.”
“The question for investors and emerging markets (EM) is not whether the Fed is going to hike rates or not. The question over the next 12 months is whether there will be negative surprises (more hikes than expected) and which emerging markets are the most vulnerable.”
State Street Global Advisors
“Resolution of China’s debt woes and a growth trough are likely to be a bigger drag than near-term fed action. While the situation today is reminiscent of the fed hike in 1994 and subsequent EM crisis, it’s important to note that the current debt in EM’s is predominantly in local currency and FX reserves still remain strong.”
Sources: Public statements, documents and websites of relevant companies. Chart is sourced from Blackrock Investment Institute.