The EM fundamentals

With the Fed allowing the September rate hike to go ‘through to the keeper’, the continued guessing games of ‘will they, won’t they’ has continued and caused some very strong market reactions.

Source: Bloomberg

Normally a maintaining of a stimulus measure is good news, but the markets are telling you otherwise.

Since the Fed speech last Friday until just before the release of Yellen’s speech this morning, these moves are catching my eye:

  • US ten-year has lost 14 basis points from 2.26% to 2.12%
  • Expectations of a hike in December have gone from 64% to 41% (lowest read yet)
  • The MSCI Emerging Markets currency index has lost 1.7% to a record all-time low
  • The USD spot index (not to be confused with the USD index) is up 1.4%
  • The EURIBOR is showing increased pricing of cuts to European rates

The Fed statement on 17 September was as dovish as it could get. The economic outlook, inflation expectations and the dot plots were all shifted lower, emphasising the very dovish standpoint.

What has caused even more debate in the past week is whether one of the three members that pushed out their economic projections Janet Yellen herself?

Although the speech this morning was in the main a reiteration of the status quo, she has been telling the markets for months that it did have enough in it to conclude she isn’t one of them on the back of the penultimate sentence in her speech, ‘Most FOMC participants, including myself, currently anticipate that achieving these conditions will likely entail an initial increase in the federal funds rate later this year, followed by a gradual pace of tightening thereafter.’

With the currency markets being the only market open at the time of statement, this chat illustrates the strength seen in USD on the transcripts release. USD/JPY rallied heavily on the back of these comments, and the correlation of the chat would suggest US futures would move that way too.

However, the next question is, which markets lead which? Ahead of the open of US futures, the match was to the downside and that could explain why USD/JPY has waned after the speech and given back half the initial move. US futures should give a clear understanding of how markets will receive this morning’s developments.

Ahead of the Australian open

We are currently calling ASX down a handful of points to 5077, however with the US futures closed, that figure is likely to change quickly.

What should be of interest to Australia going forwards is emerging markets (EMs).

Realistically, EMs have been experiencing US rate rises for the last two years. US two-year rates have climbed 55 basis points in this time to 80 basis points, the ten-year has gone from 1.8% to 2.12%, and has been as high as 3% during ‘taper tantrum’. What’s more is that EM performance over this two-year period has been historically poorer than comparison scenarios of US hikes.

That leads to a conclusion that EM fundamentals are in a state of flux and are more to blame for the underperformance. The oil back drop, primary exports prices, and the debt overhang in China will weigh on growth for a sustained period, and that will mean EMs will continue to underperform – and drag Australia with them. 

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