Examining emerging markets: implications of a Fed pause

Apr 24, 2023

Emerging market debt expert Anthony Kettle, BlueBay Senior Portfolio Manager, discusses the impact a pause on US rate hikes could have for emerging markets and what the outlook is for the asset class.

The current market backdrop suggests that central banks have made significant inroads in their fight against inflation and that the US is close to pausing its hiking cycle. Recent commentary by the US Federal Reserve (Fed) suggests that it has a preference for pausing at one of the upcoming meetings to allow time for the full impact of the hikes so far to ripple through the economy. This is understandable given the two most recent and relevant data points the US payrolls and the US consumer price index (CPI) report. While payrolls pointed to a still-resilient jobs market, the CPI showed a downside miss, with a 0.1% gain month on month versus the expected 0.2%. These slower rent gains and weaker demand show that the aggressive hiking cycle undertaken so far by the Fed is beginning to have a real impact on bringing inflation down.

Encouraging signs for emerging markets…

We believe that the implications for emerging markets are nuanced. All else being equal, this should set the scene for outperformance from emerging markets, and particularly for local markets, which have the additional benefit of high nominal yields and falling inflation. We continue to see credit markets as more susceptible than local markets in the current environment. However, we note that low cash prices and historically high yields across the sovereign universe in particular are a significant mitigant to any concerns around an increasing default rate in global credit markets. One interesting side note is that in China, there is a trend of improving credit growth, with both corporate and household loans increasing. Improving Chinese growth should be one of the key themes this year as it receives its post-Covid reopening dividend later than other countries – at the same time as the US slows on the back of the sharp tightening cycle.

Examining the emerging market outlook

A noteworthy development in emerging markets is that a potential debt forgiveness is on the cards for Ukraine. The IMF released its debt sustainability analysis on Ukraine which deemed that a future restructuring of Ukraine’s debt is necessary. Given the extreme nature of the Ukrainian situation, with the Russian invasion being the cause of the stress, we believe that official creditors may join bondholders in providing some of that debt relief.

Elsewhere in emerging markets there are many opportunities and much to think about. Improving Chinese growth lends a positive bias to emerging markets, and we prefer to express that through long positions in some of the early hikers, particularly across Latin America such as Columbia where recent reform headlines have been better than expected. We also view credit markets as an interesting alpha opportunity, given the high yields on offer, but we highlight the need for a high level of differentiation due to rising credit stress.

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