Markets are often influenced by heuristics, and in the emerging world the rule of thumb that dominates most is that when US interest rates are rising, emerging market assets are doomed to underperform, almost regardless of any other dynamic.
This is because, according to its advocates, EM economies and countries are required to borrow in dollars or other 'hard currencies', rather than in their own currency.
As US rates rise, this would be expected to lead to dollar strength, pushing up the debt repayment costs of corporates and countries in the merging world, leaving less cash for distribution to shareholders, or to reinvest in the economy.
In response to this, EM economies have historically raised their own interest rates to protect their currency relative to the dollar, dragging down the level of aggregate demand in economies.
Added to this is the notion that if US rates are rising, the likelihood is that global economic growth will slow down, prompting a retreat from risk assets, and with EMs hosting some of the highest beta asset classes, this has a negative impact for investors there, while the higher yield available on government bonds means there is less appeal to owning riskier equities, especially for an non-US investor who may benefit from the strength of the dollar in terms of the income they get from the bonds.
But does that rule of history apply in the world of today?
Guy Miller, chief economist and market strategist at Zurich, says one key difference this time is that many EM central banks, particularly in Latin America, actually lifted rates ahead of the US Federal Reserve, mitigating somewhat the impact of the US rises, while also potentially having the capacity to cut rates ahead of the Fed, and thereby stimulate economic growth.
Anuj Arora, head of EMs and Asia Pacific equities at JPMorgan Asset Management, says: “While markets have certainly been more volatile, there are reasons to be more optimistic about EM equities, including falling global inflation, which provides EM central banks room to cut aggressively, and a weaker US dollar.
"China’s economy continues to grow, though slower than expected. Valuations – currently around their long-term averages – are reasonable, and EM earnings offer upside potential.
"As always, we continue to look for opportunities in EM equities where earnings growth can compound over the long run."
Miller agrees that the dollar is likely to strengthen rather than weaken from here, as a consequence, in his view, of a deteriorating outlook for the US economy.
He believes inflation will fall in 2024, and as a consequence interest rates in the US will be cut by “the middle of next year”, which would be expected to lead to downward pressure on the dollar.
Victoria Harling, head of EM corporate debt at asset manager Ninety One, goes further, saying that while times of geo-political uncertainty such as we are currently experiencing would normally be expected to dent demand for EM assets, the capacity for those economies to cut rates gives them and advantage relative to developed markets.
