Fed-Fueled Euphoria Won't Last in Emerging Markets, Analysts Say

(Bloomberg) -- Assets across emerging markets are rising after Jerome Powell signaled that traders were right to assume the Federal Reserve may cut rates this month for the first time in more than a decade. But the rally, warn analysts and investors, may be short-lived.

Here’s why:

Bryan Carter, London-based head of emerging-market debt at BNP Paribas Asset Management:

• “Chairman Powell very pointedly did not dispel market pricing of a July rate cut. This is good for EMs generally, as it is pro-growth, rates-supportive and dollar-negative”
• “For our portfolios, it is neutral as we have an overweight in pro-growth assets including high-yield bonds and corporates but a negative view on EM rates”
• “We still think local markets are too euphoric on a potential Fed cut. South Africa’s local-bond market is pricing two rate cuts, Brazil’s is pricing three, Mexico’s four. These countries face fiscal and monetary pressures, they may try to follow the Fed with an insurance cut, but they are not going to meet the market’s expectation for a full cycle of cuts”
• “The Fed minutes reflected that a plurality of FOMC voters either did not see the need for cuts or wanted to be convinced before acting. Despite Powell’s comments, we think some of this euphoria will eventually need to be walked back”

Piotr Matys, a London-based emerging-markets strategist for Rabobank:

• “We are not convinced that ‘the rally of everything’ will prove sustainable as no amount of Fed easing will likely be sufficient to prevent global recession if trade tensions inevitably escalate again. However, we also fully acknowledge the powerful impact the prospect of easy money can have on risky assets over the short-term horizon and we have no intention to fight against it”
• “The amount of dovishness from Fed Chairman Powell keeps the short-term bias skewed to the downside in USD/CEEMEAs. When even USD/TRY is leaning lower, it says a lot about market sentiment towards the CEEMEAs”
• “It is absolutely crucial to emphasize that if it was not for the prospects of major central banks led by the Fed flooding financial markets with liquidity, USD/TRY would have been on its way to yet another all-time high after President Erdogan essentially confirmed that Turkey does not have an independent monetary policy”

Mitul Kotecha, senior emerging-markets strategist at TD Securities in Singapore:

• “Powell’s testimony has effectively sealed expectations for a 25-basis point rate cut at the end of this month. Although markets had priced in a large degree of Fed easing, Powell’s confirmation will provide a further fillip to EM assets. The fact that U.S. equities moved higher, U.S. yields moved lower, and the USD slipped, highlights that Powell’s message was not priced in. It should give support to EM currencies today as well help EM bond markets”
• “Powell’s testimony and likely 25-basis point easing this month is likely to help spur EM central banks to cut rates. The next CB decisions in Asia are Bank of Korea and Bank Indonesia. There is a growing likelihood that both central banks ease policy, if not next week, then in the next few months. The same can be said for most other Asian central banks, likely taking the lead from the Fed, lower inflation and softening growth momentum”

Jason Daw, head of emerging-markets strategy at Societe Generale in Singapore:

• “The market is aggressively priced for Fed easing and there seems to be a consensus that U.S. rate cuts will weaken the dollar against EM”
• “We see it differently; rate cut expectations have served to stabilize EM FX this year and the mere act of rate cuts to catch up with market pricing should not be incrementally positive”
• “The dovish Fed now removes the last hurdle for Asian central bank to ease”
• “The market tends to front-load a higher level of Asia central bank easing than is ultimately delivered in the cuts themselves, but at this juncture, any sporadic pricing out of Asia central bank easing would be a technical adjustment, not a fundamental shift”

Stuart Ritson, portfolio manager at Aviva Investors in Singapore:

• “The tone of the comments was more dovish than anticipated and the market increased the probability of a 50-basis point cut in July. This has supported EM currencies generally but especially the higher yielders, which we would expect to continue given the low-volatility environment and accommodative central banks”
• “It increases the chance we see the start of an easing cycle in Indonesia next week”

--With assistance from Tomoko Yamazaki, Chester Yung, Netty Ismail, Dana El Baltaji and Srinivasan Sivabalan.

To contact the reporter on this story: Lilian Karunungan in Singapore at lkarunungan@bloomberg.net

To contact the editors responsible for this story: Tomoko Yamazaki at tyamazaki@bloomberg.net, Shikhar Balwani

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