HOW will higher US interest rates play out for emerging markets?
Historically, the answer is not well. As the US Federal Reserve lifts rates, the conventional wisdom is that emerging market economies need to keep pace to avoid capital outflows, putting a dampener on their economies.
But there are some nuances to keep in mind that might mean this time is different, says Pendal’s James Syme.
“There’s a lot of concern in market that when the Fed starts hiking, emerging markets are going have to put through a big chunk of interest rate hikes in order to keep up,” says Syme, who co-manages Pendal Global Emerging Markets Opportunities fund.
“But our view is that emerging markets have been hiking hard for some time now — and it actually looks like it is the Fed that is significantly behind the curve.”
Brazil’s central bank has raised policy interest rates nine times since the first post-pandemic hike in March 2021. Rates have been lifted by 9.75 percentage points to 11.75 per cent.
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“The implication is that if the Fed has to do 400 basis points in hikes, that doesn’t mean Brazil is going to have to.”
The story is similar in other emerging markets.
The South African Reserve Bank has lifted rates three times by 25 basis points each since it started hiking in November. Mexico has lifted rates seven times from 4 per cent to 6.5 per cent since mid-last year.
Syme says the Mexican example illustrates the difference between the way the US and emerging markets are tackling inflation.
“Think about how tightly coupled Mexico and the US are. Mexican consumer price inflation is about 7.5 per cent, a percentage point slower than in the US. But Mexican policy rates are six percentage points higher than the US.
“If you look just at the inflation dynamics, yes you might need some more hikes out of some of these emerging markets central banks to get to the top of the cycle. But the central bank that looks like it’s going to have to go a lot quicker is the Fed.
“And that doesn’t automatically turn into a one-to-one relationship with hikes in the emerging world.”
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The implication for emerging markets is they look to be in much better shape to weather the US Fed’s interest rate tightening cycle this time around, says Syme.
Still, there is a question for investors as to why the Fed is moving more slowly than its emerging markets.
“Maybe the Fed is right — maybe there’s much more deflation coming than we can see in trailing data,” says Syme.
“But if that’s the case, then we could be getting to the top of emerging markets interest rate cycles.
“If that’s true, maybe we can start cutting rates again.”
James Syme is a senior portfolio manager of Pendal’s Global Emerging Markets Opportunities Fund with Paul Wimborne.
The fund aims to add value through a combination of country allocation and individual stock selection.
The country allocation process is based on analysis of a country’s economic growth, monetary policy, market liquidity, currency, governance/politics and equity market valuation.
The stock selection process focuses on buying quality growth stocks at attractive valuations.
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