Fed Rate Decision

Can it actually help emerging markets?

Ask any analyst about the immediate impact of the Fed rate hike and the answer will be “Risk-off trade”. They are not entirely wrong. A rate hike in the US will force many fund managers to shift to buying US bonds in search of that elusive higher rate of return. More so considering that even at near zero rates, there are enough fund managers willing to buy US bonds. So the impact of a rate hike on emerging markets will obviously be negative as it will result in capital outflows.

Global brokers like J P Morgan are now veering around to the view that a rate hike could actually help emerging markets. Sounds ironic, but here is how it could happen…

End of uncertainty…

One of the obvious outcomes of the rate hike is that it could put an end to the uncertainty surrounding the Fed. For too long the Fed has held on to rates for fear of upsetting the delicate balance of global markets. This delay has not served the purpose since it has only served to accentuate the risk-off trade. The view is that actually hiking rates could end the uncertainty surrounding the Fed action and permit fund manages to allocate funds to emerging markets more freely. This is more so because if the Fed provides guidance on future rate hikes, then fund managers have a clearer guidance of rates and will thus enable them to allocate funds to emerging markets with a greater degree of certitude. In the final analysis, emerging markets may actually benefit.

Welcome, risk-on trade…

Emerging markets tend to benefit from a risk-on trade as it ensures fund managers are willing to take on that additional risk of emerging markets. According to J P Morgan, most fund managers are skeptical of emerging markets not because of the rate hike but because of the uncertainty surrounding it. Once the Fed hikes rates, there will be greater certainty in the minds of fund managers to take on the additional risk of emerging markets. Ironic as it may sound, a rate hike with a clear guidance may actually trigger a risk-on trade benefitting emerging markets in the process.

Will transmit growth conviction…

Most fund managers look at rate decisions very differently. A rate hike is also an indication that the US is growing faster than other developed economies. A strong US has normally been positive for emerging economies. A rate hike will be interpreted as an indication that US is growing; with its spillover benefits for emerging markets across the world. Hence there is no better way to transmit a growth conviction than to hike the Fed rates. Ironic as it may appear at this point of time, a rate hike may end up benefitting emerging markets! ©

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