The US Federal Reserve’s confirmation on Wednesday that it would raise its funds rate by 25 basis points to a range of 25-50bp was largely priced in, note fund managers, but the big question now is: what next?
Market expectations are that hikes will come at a slower pace, with three rises in 2016, than Fed projections of four next year, although there is a much disagreement on whether the next one will come in March.
There is, however, a strong consensus among fund managers that while emerging markets remain vulnerable to US monetary tightening and deserve caution, Asia is the EM region likely to prove most resilient to further hikes.
Ken Taubes, head of investment management at Boston-based Pioneer Investments, noted that higher rates would hurt those countries with significant external dollar-denominated debt. Based on Pioneer’s Vulnerability Index, Asia is the least vulnerable EM region to US tightening, with China, India and Philippines marked out as the most resilient.
Rating agency Fitch takes a similar view, citing India, Korea and the Philippines as relatively less vulnerable to external financing risk. Such countries’ position as net commodity importers will also support their position in light of collapsing commodity prices and global oversupply in many raw materials.
Gary Greenberg, head of global emerging markets at UK-based fund house Hermes, noted that China, Korea, Indian and Taiwan – which account for half the global EM benchmark – were maintaining healthy current accounts and FX reserves. Hermes is maintaining overweight positions in such countries, which will be relatively less affected as US monetary policy tightens.
As for the Fed’s next steps, the broad expectation – backed up by Fed chair Janet Yellen’s statement on the decision – is that further rate hikes will be gradual over the coming three to four years, rising to a peak of between 2.5% and 3.5%. The latest Federal Open Market Committee forecast is for four rate hikes next year, but market expectations are for a slightly slower pace of three.
“The Fed does not want to be overly predictable, which Chairman [Alan] Greenspan was criticised for in the 2004 [rate rise] cycle,” said John Bellows, portfolio manager and research analyst at Western Asset Management. “The obvious way to deviate from a mechanical hiking path is to skip a quarter.”
While a more dramatic rise in rates seems unlikely, investors should still be prepared for much sharper rises than are expected, said Keith Wade, chief economist at Schroder Investment Management.
“The conditions are there,” he noted. “They include, amongst other things, a number of emerging economies heavily dependent on external borrowing and unprecedented quantities of ‘electronic money’ created through quantitative easing which is currently not reaching the real economy.”
The risk exists for such a move but it would be inadvisable, said Andrew Swan, head of Asian equities at BlackRock. Stronger US data could “lead to a more hawkish Fed in 2016, which could see more aggressive tightening and with that policy error in a low-growth world”, he noted.
Of course, views vary widely on whether the Fed pulled the trigger at the right time in the first place, with some arguing it may not have moved early enough, while others saying the rise was premature.
Francis Scotland, portfolio manager of global macro strategy at Brandywine Global, felt inflation expectations did not yet justify the hike and also that collapsing commodity prices and widening credit spreads had warned against premature “lift-off”.
On the other hand, David Buckle, head of quantitative research at Fidelity International, said: “I don't believe the Fed has raised too soon. The labour element of the Fed’s dual mandate says that lift-off is overdue, the inflation element says it’s way too soon. Convergence of these two criteria is key from here, the employment data mustn’t deteriorate and we must start seeing some hint of inflation.”
Such divergence reflects that we are in totally uncharted territory - suggesting that investors should be covering all their bases as best they can. That will not be easy, to say the least.