Fed pause could reignite ‘wall of money’ for emerging markets, trade group says

A pause in tightening by the US Federal Reserve could be a boost to emerging markets as investors look beyond China-related securities for growth, according to the Institute of International Finance.

In a new research report, Robin Brooks, the trade group’s chief economist, and associate economist Jonathan Fortun said that much of the pickup into emerging markets stocks and bonds this year has been driven by China, but that has broadened in recent weeks, particularly in equities.

The Fed’s recently changed stance on further rate hikes could “reignite a wall of money” into emerging markets, according to the report.

“What made last week’s [January 29 to 30 Federal Reserve] meeting so notable was how much of the Fed’s long-standing narrative was dropped, including the tightening bias, the [quantitative tightening] path and risk assessment,” Brooks and Fortun said. “Perhaps the most important change was the addition of ‘patient’ to the statement, a loaded term in Fed parlance.”

“The last time ‘patient’ made an appearance was in December 2014, when

it replaced ‘considerable time’ and signalled a shift to cautious tightening,” they said. “‘Patient’ stuck around for the January 2015 meeting, was dropped in March, and the Fed eventually hiked for the first time in December 2015. ‘Patient’ in other words signals a prolonged pause.”

The IIF economists said they expect the Fed to hold off on any additional rate hikes until the second half of the year, when they expect two.

In a separate note this week, Jon Harrison, managing director, emerging markets macro strategy at TS Lombard, said that the outlook for growth in China and the timing of when further stimulus measures by Beijing affect the economy are the biggest risk to emerging market investors.

As a trade war with the United States escalated last year, China’s economy grew at its weakest pace since 1990, with the gross domestic product growth rate at 6.6 per cent in 2018.

“We met with 20 institutional investors in London in late January during our China macro marketing trip,” Harrison said in a research note. “In general there was greater optimism than during our previous visit in November, centred on the prospect of new stimulus. We caution first that stimulus policy is not yet sufficiently strong to stabilise growth and second that there is a growing risk of deflation.”

Richard Titherington, the emerging markets and Asia-Pacific equities chief investment officer at J.P. Morgan Asset Management, said that China has a greater incentive to come to a resolution on trade.

The US has set a March deadline for the world’s two largest economies to reach an agreement on trade. If no deal is reached, US President Donald Trump has threatened to raise tariffs on some US$200 billion of Chinese imports to 25 per cent.

“The trade dispute has hurt China, not just in terms of the stock market declines, but also consumer confidence and Chinese company capex,” Titherington said. “With China under pressure, we expect them to seek compromises. Any success on those fronts would be relatively positive for [emerging markets].”