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August 16, 2016

Will the Fed Crash The Emerging Markets Party ?

Stronger U.S. jobs data fueled speculation earlier this month of more Federal Reserve (Fed) rate hikes. Such expectations were overblown. This week’s chart helps explain why.

BlackRock’s “Yellen Index” (our gauge of 10 key labor market indicators closely followed by the Fed) has picked up, but it’s well below the level before the Fed’s December rate rise, as the chart above shows.

The implications for EMs — and investors

Emerging market (EM) assets are typically vulnerable to Fed rate hikes. Higher U.S. rates often buoy the U.S. dollar and weigh on commodity prices. The reaction is likely to be muted at the next rate increase. We expect the Fed to raise rates just once this year — likely in December — and to proceed cautiously given the unevenness of the domestic economic recovery, as highlighted by weak retail sales data released last week, and global growth uncertainties.
The Fed has not signaled a desire to tighten. U.S. jobs data are encouraging. Yet inflationary pressures, while picking up, remain modest. Some evidence suggests the U.S. unemployment rate could fall further without triggering significant inflation. We think the Fed might be willing to let the economy run hot before raising rates. This mirrors developments elsewhere. Bank of England (BoE) Governor Mark Carney last week signaled the BoE may tolerate a period of above-average inflation.
The lower for longer outlook for Fed rates extends investors’ reach for yield, and we see it further supporting EMs. It buys time for EMs to implement structural reforms, such as India’s recent tax reform and Indonesia’s renewed push for fiscal reform. This could enable select EMs to be more resilient when the Fed eventually normalizes rates.
We like EM debt, where spreads remain attractive, and are neutral on EM equities. We prefer domestically oriented stocks and EMs with reform momentum. Read more market insights in my Weekly Commentary.
About the Author: Richard Turnill is BlackRock’s global chief investment strategist. He is a regular contributor toThe BlackRock Blog.
The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters.

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