Fed's Powell Gets an `F' From Bass Amid Emerging-Market Risks

(Bloomberg) -- Federal Reserve Chair Jerome Powell flunked today’s test at a pivotal time for emerging markets, according to Kyle Bass.

The founder of Hayman Capital Management, said the developing world is already "flashing red" thanks to a slowdown in China, and the U.S. now appears headed for a mild recession late next year. Global stocks slid Wednesday as the Fed raised rates for the fourth time this year and cut its forecast for hikes in 2019 to two from three. Markets had been priced for just one.

"Powell wasn’t dovish enough," Bass said in an interview from Dallas. "Clearly, the market is telling him he gets an F."

Here’s how emerging-market analysts and investors interpreted Powell’s comments:

Brendan McKenna, a currency strategist at Wells Fargo in New York:

• “Even though the U.S. economy is still strong, the growth outlook is still slowing and the global economy is slowing as well, so EM currencies typically don’t respond too well when there is slowing global growth”
• McKenna says the Fed statement was dovish, but not as much as he expected; central bank didn’t talk about approaching neutral rate and instead, mentions further gradual rate hikes
• In scenario of two more rate hikes next year, as dot plot indicates, McKenna favors Mexican peso and Brazilian real

Harvard University economist Carmen Reinhart:

• The Fed isn’t particularly troubled by a rise in volatility across global markets, both in the emerging and developed worlds, says
• Added dovishness probably comes from tamer U.S. inflation rather than concern on real economy
• Combination of U.S. interest rates, dollar strength and commodity prices suggest financial markets are underestimating risks in lower-grade U.S. corporate debt rather than overestimating risks in EM fixed income
• "AMLO is not doing a lot for EMs these days"

Michael Gomez, head of emerging markets at Pacific Investment Management Co.

• Emerging markets responded "reasonably constructively" to today’s Fed decision.
• Also watching commodity prices and risk appetite as seen in equity prices
• "Given the recent headwinds, we continue to believe a highly differentiated approach to EM markets exposure is warranted and retain our higher-quality bias"

Chris Diaz, a money manager at Janus Capital Management in Denver

• Fed’s dot plot was dovish, but its statement needed to be more so to spur gains in emerging-market assets
• Many market participants wanted the Fed to stop hiking now; dot plot still points to two rate increases next year
• With the Fed continuing to tighten, Diaz said he would avoid investing in countries with large external financing needs as they’re more vulnerable to rising yields
• “Many were expecting a more dovish fed. Some expected ‘further gradual increase’ could be removed and it was not. The message is the Fed is not done tightening and risk markets did not want to hear that, including emerging markets"

Michael Roche, a fixed-income strategist at Seaport Global Holdings in New York

• Emerging markets may become more attractive now that the Fed has completed the majority of its rate hikes and has a more dovish outlook
• "With the bulk of projected Fed Funds rate hikes now in the past, the negative hit to EM from future hikes will be a diminishing phenomenon"
• "As the tightening cycle is seen ending, more and more capital will be attracted to EM"

Danny Fang, a strategist at BBVA in New York

• Emerging-market assets will gather strength as the Fed dials back the pace of rate increases and global economies expand
• Initial market response "probably to account for a not-so-dovish Fed," Fang says. "Over time, a not-so-hawkish Fed combined with still-positive growth globally should back EM assets"
• "The slower growth was already pretty well-considered. Most people were expecting growth deceleration in China, U.S., Europe etc. Markets were probably thinking that the Fed was going to be more dovish than it is now"

Tai Hui, chief market strategist, Asia Pacific, J.P. Morgan Asset Management:

• The Fed’s caution and flexible policy approach combined with a lack of inflation pressures this late in the economic expansion are both long-term positives for U.S. stocks
• Sees a more tempered Fed rate hike projection as a positive in the medium term. The Fed’s projection on 2019 growth remains solid, which is crucial for the global trade cycle
• "Yet, a more measured approach in raising rates should take away some of the support to dollar strength, and this helps to encourage more capital flow back to EM/Asia equities and fixed income, especially since valuation has corrected to undemanding levels following this year’s declines”

Hak Bin Chua, economist at Maybank Kim Eng Research Pte in Singapore:

• Emerging markets are not out of the woods
• "The Fed is not stopping as yet and further rate hikes, albeit gradual, will pressure EM currencies. We expect central banks in Indonesia and Philippines to hike rates in 2019 but at a more moderate pace to keep up with the Fed"

Toru Nishihama, economist at Dai-ichi Life Research Institute Inc. in Tokyo:

• Market participants’ eyes are probably on the Fed’s view about softer U.S. economic growth in 2019, which hurts risk sentiment and weighs on emerging-market assets, though a slower pace of rate hikes in the U.S. should cap the dollar’s gain
• Slowdown in global growth means shrinking trade worldwide, hurting many emerging markets that depend on exports for their growth
• But because the Fed’s rate path is slower next year, that eases a lot of pressure on some developing markets in terms of their own rate hikes

--With assistance from Enda Curran and Yumi Teso.

To contact the reporters on this story: Ben Bartenstein in New York at bbartenstei3@bloomberg.net;Aline Oyamada in Sao Paulo at aoyamada3@bloomberg.net;Justin Villamil in Mexico City at jvillamil18@bloomberg.net

To contact the editors responsible for this story: Rita Nazareth at rnazareth@bloomberg.net, Alec D.B. McCabe

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