Fed isn’t spooking emerging markets
NEW YORK: Emerging-market investors are totally okay with the hawkish Fed, it appears. Gauges of developing-nation currencies and stocks are near 18-month highs even after Federal Reserve chair Janet Yellen’s testimony last week spurred increased bets that policymakers may raise rates as soon as March. The benchmark emerging-market equity index is up almost 10% this year, while the equivalent currency gauge is off to its best start since 2012.
The phenomenon is a bit unusual. Tighter US monetary policy often spells trouble for emerging markets as steeper yields pull traders away from riskier assets. But investors have known for a while that rate increases were coming and are instead focused on the idea that a stronger US economy will fuel growth in developing nations, bolster corporate profits and support prices for the commodity exports that many of the countries rely on.
“EM is dirt cheap,” said Jan Dehn, the London-based head of research at Ashmore Group, which oversees $52 billion of assets. “This rotation from developed-market bonds into stocks and emerging markets has triggered a return to positive correlations between EM local markets and US stocks.”
Dehn sees conditions similar to the start of the bull market in developing-nation assets from 2003 to 2007, when the MSCI Emerging Markets Equity Index index more than quadrupled and its currency counterpart almost doubled.
A period of uncommonly low volatility also makes carry trades with emerging currencies “very attractive”, according to Andres Jaime, a strategist at Barclays in New York. Adding to the appeal are accommodative policies by central banks and optimistic global expansion forecasts.
The MSCI Emerging Markets Currency Index has rallied 3.8% in the first few weeks of 2017, and 21 of the 24 developing-nation currencies tracked by Bloomberg are in the green. That came after a selloff in November following Donald Trump’s surprise election victory, which briefly sent investors in search of the safest assets.
Judging from the seven notable emerging currency rallies of the past six years, the current outperformance has legs to continue, says Morgan Stanley strategist Gordian Kemen, who recommends staying long on the Turkish lira, Mexican peso, Argentine peso and Indonesian rupiah.
Goldman Sachs has cautioned, however, that global macro risks are a reason to be cautious on emerging-market stocks, and has withdrawn its recommendation to go long in Brazil, India and Poland.
And there are some signs that the rally has gone too far. The MSCI currency and equity gauges both have relative strength indices above 70, levels that point to gains being overdone.