Emerging markets are "on pins and needles," with the market worrying: Did the Fed's "50 basis point rate cut in September" go wrong?

Wallstreetcn
2024.10.21 03:45
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Market concerns that the Federal Reserve's significant rate cut in September may have been implemented too early and may be difficult to sustain. The cost of funds borrowing in the United States may remain high, potentially causing emerging market assets to struggle, leading global investors to hesitate

The Federal Reserve opened a loose cycle in September with a significant 50 basis point rate cut, which already surprised the market. However, the September non-farm payroll data released just half a month later far exceeded expectations, leaving the market feeling uncertain. The pace of subsequent rate cuts by the Federal Reserve has become increasingly unpredictable, with concerns rising that "a 50 basis point rate cut in September was unnecessary."

Seth Carpenter, Chief Economist at Morgan Stanley, recently stated that while he personally does not believe that the 50 basis point rate cut in September was a mistake, he does believe that if the Federal Reserve had known how strong the September non-farm payroll data would be, coupled with considerations of revisions from previous months, they would have only chosen to cut rates by 25 basis points in September.

This viewpoint also partly explains the recent trends in risk assets in emerging markets. Investors are on edge, fearing that the Federal Reserve's decision to significantly cut rates in September may have been premature and unsustainable. The cost of borrowing in the United States may remain high, putting emerging market assets in a difficult position.

Martin Bercetche, a hedge fund manager at Frontier Road Ltd in the UK, commented:

With U.S. bond yields exceeding 4% and economic activity in the United States picking up, people are starting to question the Federal Reserve's view on the rate cut cycle... Last month may have been a wrong start.

Investors are "hesitant" towards emerging markets

In less than a month, the benefits of the Federal Reserve's rate cut to emerging markets were quickly overshadowed by new risks, such as higher U.S. bond yields, a strong U.S. dollar index, and increased volatility in the foreign exchange options market.

Although initially, emerging market assets received a boost, they were first hit by strong U.S. economic data and then impacted by the resurgence of "Trump trade." Many economists are now concerned that considering Trump's core agenda of tariffs and trade protectionism, once these policies are implemented, they may weaken the demand for U.S. exports in emerging markets and drive up U.S. prices.

Paul McNamara, Investment Director at Gam UK Ltd. in the UK, stated:

A strong U.S. economy without inflation is beneficial for emerging markets, but once sustained inflation appears, it will not only further delay the Federal Reserve's rate cut, but also drag down all risk assets in the medium term.

In conclusion, various risk factors have suppressed the usual returns that a loose Federal Reserve cycle would bring, causing global investors to hesitate towards emerging markets.

From stocks to bonds, investors' positioning in emerging markets is disrupted

Hedge funds are increasing their bets on the appreciation of the U.S. dollar, especially against emerging market currencies that are vulnerable to tariff policies.

At the same time, emerging market stocks have fallen back to worrying lows after a brief rebound.

Emerging market currencies and local currency-denominated bonds are also showing a downward trend, marking the worst single-month performance since February 2023.

Furthermore, the yield curve of emerging market bonds is also affected. Typically, when interest rates are expected to fall, investors tend to prefer buying long-term bonds to earn higher returns during rate cuts. However, the opposite is true now, with short-term bonds gaining more favor Since the Fed's rate cut in September, bonds with a maturity of over ten years have caused investors a loss of about 3.6%, while bonds with a maturity of less than three years have seen a slight gain.

Analysts say that investors originally expected emerging market central banks to follow the Fed's rate cut, thereby boosting their bond yields. However, now that these central banks are acting cautiously after not understanding the Fed's actions, it has disrupted investors' positioning in emerging market bonds.

Anders Faergemann, Senior Portfolio Manager at asset management firm Pinebridge Investments, stated:

Ultimately, local currency bonds in emerging markets should benefit from the global easing cycle. However, from a total return perspective, the rebound of the US dollar and countries delaying monetary easing may trigger some profit-taking.