SINGAPORE (July 23): Emerging markets (EMs) have been particularly hard hit by the tightening cycle in the US. On July 17, US Federal Reserve chairman Jerome Powell’s testimony to the US Senate indicated continued rate hikes, given faster US GDP growth expected for 2H2018. Tax cuts are expected to provide demand- and supply-side support to US growth over the next two to three years, Powell said. Also, like other central banks, the Fed sees the US-led trade war setting off alarm bells, but not enough to slow global growth dramatically.
“Inflation surprise would entail the risk of faster tightening than forecast, so bond markets may suffer even more, warranting an underweight positioning on most fixed-income assets,” notes Xavier Denis, head of Cross Asset Research, Lyxor Asset Management. Further tightening would also lead to continued US dollar strength against EM currencies. Against the greenback, the rupiah, ringgit and renminbi have all lost around 6% since the start of the year.
“We have downgraded to neutral on EM equities and we are underweight on EM debt (hard currencies). A stronger USD, tighter USD liquidity and rising oil prices are headwinds to the overall asset class,” Denis says in a recent report. “China could receive some modest overweight, given its closed capital account and solid expansion, despite some growth deceleration.”