As we’ve previously noted, despite recent signs of improvement, investor sentiment about emerging markets has been fundamentally depressed over the past year—and one concern driving the asset class’s underperformance is the potential impact of U.S. interest-rate hikes and a stronger U.S. dollar (USD).
Concerns about the liftoff of U.S. interest rates by the Federal Reserve (Fed) and the evolution of the USD have weighed on performance in emerging markets over the past few years. But is that concern warranted? Emerging markets have outperformed developed markets during most Fed tightening cycles since 1969. The only exceptions occurred when tightening cycles were considered “violent”—that is, the rate increases came sooner than the market anticipated or were stronger than the market anticipated, or both.
We believe the current Fed rate-hike cycle is likely to be in the “benign” category. First, the Fed has painstakingly communicated a slow and gradual pace of rate hikes. Second, concerns about gross domestic product (GDP) growth in the United States and abroad, global deflationary pressures, and relatively tame wage growth in the United States will, in our view, limit the Fed’s actions.
In particular, inflation is currently well below the Fed’s target of 2%, and inflation expectations are below levels at which the Fed has actually implemented easing policies (multiple rounds of quantitative easing, or QE) in the past. However, we believe wage inflation is a critical indicator to monitor as a potential acceleration in wage growth could lead the Fed to hike interest rates more aggressively than the market expects.
Rate Hikes, The Dollar And Emerging Markets
June 2, 2016
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