A Fed move could be good news for emerging markets

Mark Mobius, portfolio manager of the Templeton Emerging Markets Investment Trust and executive chairman of Templeton Emerging Markets group, says a rate hike could be positive to countries with export ties that benefit from a strengthening US economy.

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 17 September, 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 increased demand for more imported goods, and a stronger US dollar relative to other emerging market currencies could put emerging markets in a more favorable trade position. Weaker currencies tend to promote exports and help manufacturers.

In contrast to the Fed, central banks in emerging markets generally are not considering the question of raising interest rates in their home countries. The largest—China—has been working to stimulate its economy through lower interest rates and other measures.

We generally see lower inflation and, therefore, lower interest rates in emerging markets going forward, despite the threat of future US interest rate actions. At the government level, emerging market government bonds in many cases are seeing higher yields, but this phenomenon does not necessarily carry through to the private sector.

To us, the key question for equity investors in all this news is, where does value lie?

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