Emerging market debt approaches turning point

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James Barrineau, co-head of Emerging Market Debt Relative, comments on how tomorrow’s Federal Open Markets Committee (FOMC) announcement could mark an inflection point for emerging market debt.

There is currently a significant degree of weakness in emerging market debt markets. One of the key reasons for this fragility has been the lack of clarity in the path of the Federal Reserve’s (Fed) interest rate policy. In the first two weeks of March, speculation over a rate hike from the Fed gathered pace, with prices aggressively falling to reflect a hawkish turn in Fed policy.

The Federal Open Markets Committee (FOMC) meeting this week is likely to be particularly influential in determining the medium-term prospects for emerging market debt.

The FOMC’s January statement said that it “can be patient in beginning to normalize the stance of monetary policy”. Opinions now appear divided on whether the Fed will remove the word “patient” from its commentary — which would imply a June hike — or if it will keep it in, which would imply a September timeframe for most observers. Whatever the outcome, the increase in market volatility and the relentless rise of the US dollar reflect the expectation of some degree of tightening.

Once we jump the initial tightening hurdle – which seems inevitable at this point, regardless of which month it starts – talk will immediately turn towards the length of the prospective tightening cycle. This is, in our view, more pertinent.

The Fed has been at pains to suggest a shallow cycle; one that will not involve consecutive meeting hikes. This would be more supportive for emerging market debt, and the economic outlook strongly supports the view. Outside of the strength in US employment, economic data has broadly disappointed.

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