Rates: US Fed Decision to Put Pressure on EM Central Banks
Emerging-market central banks are increasingly under pressure to hike rates as the Federal Reserve is poised to maintain US rates at a two-decade high at its sixth consecutive meeting on Wednesday – and this has significant implications for investors around the world, affecting various asset classes and regions.
This is the warning from Nigel Green, CEO and founder of deVere Group, one of the world’s largest financial advisory and asset managers, comes as the Federal Open Market Committee is widely expected to hold the range for its benchmark at 5.25% to 5.5%.
He says: “The Fed is expected to hold rates at the two-decade high that was first implemented last July, and markets are increasingly pessimistic about the likelihood of rate cuts this year.
“This puts the squeeze on emerging-market central banks – including countries like South Africa, India and Mexico – to hike their own rates in order to address currency depreciation, inflationary pressures, capital flight risks, and external debt servicing concerns.”
Should policymakers move to raise rates in emerging economies, global investors could be impacted. “Higher interest rates in emerging markets can lead to higher yields on government bonds issued by these countries.
This is likely to attract foreign investors seeking higher returns, resulting in increased demand for emerging-market bonds. “In turn, higher yields may also lead to capital outflows from developed markets as investors reallocate their portfolios to take advantage of better returns in emerging-market bonds,” notes the deVere CEO.
Equity markets in those countries and beyond could also be affected.
“Sectors that are sensitive to interest rates, such as financials and utilities, are likely to benefit from higher rates due to increased profitability; while those that rely on debt financing, such as real estate and consumer discretionary, will face challenges as borrowing costs rise, potentially impacting earnings and stock prices.
“These shifts influence investor sentiment and risk appetite and could lead to fluctuations in equity markets beyond the emerging economies.” The decision of emerging-market central banks to raise interest rates would also impact currency markets by influencing exchange rates and currency values.
Nigel Green says: “Higher interest rates in emerging markets will attract foreign capital inflows, leading to appreciation in the local currency.
“This affects currency pairs globally, as changes in exchange rates between emerging-market currencies and major currencies like the US dollar can impact trade flows, corporate earnings, and cross-border investments.”
He continues: “In addition, emerging markets are significant consumers and producers of commodities such as oil, metals, and agricultural products. Higher interest rates could dampen economic growth and demand for commodities in emerging markets, leading to lower prices.
“Conversely, a stronger local currency resulting from higher rates may decrease the cost of imported commodities, mitigating inflationary pressures and supporting consumer purchasing power.”
Almost all Federal Reserve officials from Chair Jerome Powell down have said they don’t expect to start cutting rates until they see more evidence that inflation is headed in the right direction and back towards the 2% target.
The deVere CEO concludes: “US rates are set to be held steady again. Focus will be on Powell’s speech after the announcement.
“We expect a hawkish tone and this will add pressure to the emerging-markets central banks to raise rates.”
