FOMC meeting presents potential turning point for emerging market debt
As the Federal Open Markets Committee meets to discuss the future direction of its monetary policy, Schroders fund manager and Co-head of Emerging Markets Debt Relative James Barrineau discusses the potential opportunities a tightening cycle presents for investors.
18 March 2015
Whatever the eventual outcome of the Federal Open Markets Committee (FOMC) meeting this week, once we jump the initial tightening hurdle talk will immediately turn towards the length of the tightening cycle.
This is, in our view, more pertinent than the question of whether the Federal Reserve (Fed) will remove the word "patient" from the wording of its commentary regarding its approach to normalising monetary policy.
The Fed has been at pains to suggest a shallow cycle; one that will not involve consecutive meeting hikes. This would be more supportive for emerging market debt, and the economic outlook strongly supports the view.
Outside of the strength in US employment, economic data has broadly disappointed. We believe that the market weakness in emerging market debt is laying the ground for better times in the future; provided our thesis is correct that the Fed will be slow in tightening rates.
A case of history repeating itself?
History is certainly on our side, though as ever, it may be difficult for investors to remember that far back. Essentially, well-telegraphed cycles have eventually led to emerging market debt rallies, once markets reflect the initial risks of tighter policy.
Nevertheless, the divergence of debt opportunities according to country remains profound. There are a number of emerging market countries that face difficulties, making a sell decision an easy call.
Emerging market opportunities
Brazil is one such country, with weak growth, high inflation, and questions over the ability to implement fiscal reform. This has led to poor sentiment despite interest rates approaching 13%.
Turkey, with a looming election and increasing political influence in markets, is another.
The next few weeks could prove a turning point in stimulating depressed emerging market debt valuations.
Russia has been a better performer and represents an overweight for our portfolios. The central bank this week has cut rates, but the easing was at best in line with market expectations, if not a bit conservative. The massive fall in the rouble, and widespread underexposure to the currency, are helping to boost the effectiveness of the rate cuts as volatility subsides steadily.
Mexico represents our other main overweight. The government took a step to steady currency volatility this week, and we expect the central bank to hike rates as soon as the Fed does. Even in a weak market, Mexico should outperform the rest of the asset class.
Turning point approaches
Provided investors are attuned to the structural and fundamental differences within emerging markets, we believe that the next few weeks could prove a turning point in stimulating depressed emerging market debt valuations.
- Fixed Income
- Emerging Markets
- James Barrineau
- Federal Reserve
- Oil Prices
- Monetary Policy
Important Information: The views and opinions contained herein are those of Schroders’ Investment team, and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds. This material is intended to be for information purposes only and is not intended as promotional material in any respect. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. It is not intended to provide and should not be relied on for accounting, legal or tax advice, or investment recommendations. Reliance should not be placed on the views and information in this document when taking individual investment and/or strategic decisions. Past performance is not a reliable indicator of future results. The value of an investment can go down as well as up and is not guaranteed. All investments involve risks including the risk of possible loss of principal. Information herein is believed to be reliable but Schroders does not warrant its completeness or accuracy. Some information quoted was obtained from external sources we consider to be reliable. No responsibility can be accepted for errors of fact obtained from third parties, and this data may change with market conditions. This does not exclude any duty or liability that Schroders has to its customers under any regulatory system. Regions/ sectors shown for illustrative purposes only and should not be viewed as a recommendation to buy/sell. The opinions in this material include some forecasted views. We believe we are basing our expectations and beliefs on reasonable assumptions within the bounds of what we currently know. However, there is no guarantee than any forecasts or opinions will be realised. These views and opinions may change. UK: Schroder Investment Management Limited, 31 Gresham Street, London, EC2V 7QA, is authorised and regulated by the Financial Conduct Authority. For your security, communications may be taped or monitored. Further information about Schroders can be found at www.schroders.com US: Schroder Investment Management North America Inc. is an indirect wholly owned subsidiary of Schroders plc, a SEC registered investment adviser and is registered in Canada in the capacity of Portfolio Manager with the Securities Commission in Alberta, British Columbia, Manitoba, Nova Scotia, Ontario, Quebec and Saskatchewan providing asset management products and services to clients in Canada. 875 Third Avenue, New York, NY, 10022, (212) 641-3800. www.schroders.com/us