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It has been a good week for emerging markets.
EM assets lit up across the board this week after the Federal Reserve refrained from accelerating its timeline for future tightening, reassuring investors who had been bracing for a more hawkish stance.
After raising interest rates as expected by 25 basis points on Wednesday, the Fed confounded expectations that it could step up the pace of rate increases for the rest of the year by sticking to its December outlook for three rate rises in 2017.
EM stocks ripped higher, with the MSCI Emerging Markets index set to end the week 4.3 per cent higher, making it its strongest week in a month and extending the gauge to its highest level in 20 months.
EM currencies also climbed sharply, with the benchmark JPMorgan Emerging Market Currency index eyeing a 1.6 per cent gain over the week – the biggest gain in six weeks. Within this, the Mexican peso is up 2.4 per cent over the same period and briefly touched a 19.05 per dollar — a level not seen since Donald Trump’s presidential victory.
But the biggest gainers were the South African rand and the Turkish lira, both climbing more than a 3 per cent over the five trading days.
The sharp moves come as some in the market parse through the Fed’s cautious comments and wonder whether the central bank might have once again overestimated how many hikes it will deliver.
“Although [the Fed] left the ‘Dots’ unchanged, the tone of the Committee’s forecast turned a bit more bearish,” said Steven Ricchiuto, chief US economist at Mizuho.
“Without any real upside momentum in the core or a broadening out in the inflation base they hiked rates. Moreover, they hiked rates and went more fully towards three from two 2017 rate hikes even as the Atlanta Fed cut its Q1 GDP projection to 0.9%.”
The prospect of higher US interest rates tend to rattle EM assets – in part by driving up the greenback and raising the costs for countries that have a lot of dollar-denominated debt and by drawing investors’ cash back into US assets at the expense of developing markets.
So, any pull back in expectations would create a favourable environment for flows into higher yielding EM assets.
“We note that emerging markets FX is poised to continue outperforming developed market FX from a relative strength perspective,” said analysts at RBC Capital Markets.
Aside from the Fed, the Mexican peso got an additional boost from Trump’s top trade adviser Peter Navarro, who said this week that the US wants Mexico and Canada to unite in making “regional powerhouse” of trade — suggesting that the Trump administration might take a softer stance on trade with its southern neighbour.
EM assets have also been supported by a rebound in commodity prices as well as continued signs of strength in the US economy, which is generally considered a plus for export dependent EMs.