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A Fed Move Could be Good News for Emerging Markets

Emerging Markets

After months (if not years) of speculation and debate, the US Federal Reserve (Fed) has left the financial markets in a holding pattern once again, deciding to keep its benchmark short-term interest rate steady at near zero. In our view as investors in emerging markets, this isn’t necessarily positive news, because we are still left with the uncertainty that has been plaguing the market for some time. We know that the markets dislike uncertainty, so we could also be left with continued volatility through year-end.

At the conclusion of its two-day policy meeting on September 17, the Fed left the federal funds rate unchanged, citing low inflation and instability in the global economy. I believe that once the Fed does take action it will not be the start of an aggressive tightening regime. With other central banks around the world moving in the opposite direction—lowering interest rates—the Fed can’t have too strong an impact and is likely to be extremely cautious and incremental with any future actions. My feeling is that the underperformance in emerging markets overall this year can be partly attributed to the uncertainty about interest rates. We saw a similar type of downturn in emerging markets two years ago, when the Fed first started hinting at increasing interest rates—which was dubbed the “taper tantrum.”

Some commentators have stated that emerging markets have entered a vicious cycle of capital outflows, currency weakness and liquidity with higher interest rates, which has resulted in weaker growth. This, in turn, has prompted more capital outflows, feeding into a negative loop.

On the other side of this equation are the positive aspects. If in coming months the Fed feels confident enough in the US economy to raise interest rates, it could be viewed as positive news for emerging markets, particularly those with export ties that benefit from a strengthening US economy. We would anticipate a stronger US economy would likely bring...