Fed’s dovish rates turn could unleash rally in emerging markets
The U.S. Federal Reserve revealed Wednesday that it is abandoning its “patient” approach to monetary policy — and emerging markets may wind up the biggest beneficiaries.
Fed Chairman Jerome Powell held the benchmark interest rate steady between 2.25 and 2.50 per cent, but he signalled that the central bank may be inching closer to cutting rates for the first since December 2016. “Many FOMC participants now see that the case for somewhat more accommodative policy has strengthened,” Powell said at a news conference. The decision to hold rates was met with a dissenting vote for the first time during Powell’s chairmanship.
Emerging markets will have their eyes on the Fed as it inches closer to a possible rate cut, according to Laurence Bensafi, RBC Global Asset Management deputy head of emerging markets equity.
Should the U.S. cut rates, the move would open the door for central banks in emerging markets to do the same, she said. Chile pre-emptively did just that last week with a surprise cut of 50 basis points, while Indonesia strongly signalled a coming rate cut by easing its reserve ratio on Thursday.
A cut in the U.S. would leave the greenback weakened, Bensafi said, and immediately boost the value of emerging market currencies. This new environment would make emerging markets ripe for a rally.
“If we were to see an easing cycle in the U.S., that would be very positive,” Bensafi said in an online webinar. “Having a lower dollar will help (emerging markets) currencies, which are very cheap at the moment, and we will see a big rally in our markets.”
Emerging markets stumbled in 2018 and have continued to do so midway through 2019 primarily because they were caught in the crossfire of the U.s.-china trade war. In 2017, the MSCI Emerging Markets Index rose 33 per cent, widely outpacing the U.S., but trade tensions along with concerns of global growth led to the index contracting by 16.5 per cent last year.
A promising start to 2019 has since been dulled by further tensions between the U.S. and China.
Coincidentally, it’s those tensions that are forcing the Fed to rethink its monetary policy. One day after the Fed struck a more dovish tone, both the Shenzhen and Shanghai indexes in China were up by more than two per cent.
Easing U.S. interest rates may be exactly what some emerging markets need to see that rally continue, according to Bluebay Asset Management EM senior sovereign strategist Graham Stock. Thursday’s market performance, he said, showed that emerging markets were already benefiting from a “knee jerk inflow into riskier assets.” They would continue to do so with a rate cut in the U.S. — as long as it was made for the right reason.
Central banks in emerging markets won’t line up to cut rates if they feel the U.S. is only doing so because the Fed is worried about a recession. They’ll also have to be careful to avoid rushing a cut, especially in cases where inflation is still sitting above target. Brazil, as an example, struck a more dovish tone after the Fed’s announcement, but likely still does not have the room to cut rates, according to Stock.
If we were to see an easing cycle in the U.S., that would be very positive. Having a lower dollar will help (emerging markets) currencies.