EM risk from Fed tightening - Is this time different? Yes, but ....

 

The hawkish Fed policy is bad for EM financial markets, but there has not been an EM financial crisis for some time. EM markets are in much better shape than in the 1990's, yet that does not mean they will be immune to a significant rate shock especially if the purpose of the rate rise is to cut aggregate demand. There may be opportunities with holding EMB bonds, but we may not be there yet as the market reprices global interest rate risk. See "Emerging Markets and the Hiking Cycle: This Time, Really, May be Different" for this more optimistic perspective. 

The EM equity and bond indices have changed significantly over the last 20 years. The EM bond benchmark is much more diversified with less exposure to Latin America where past crises have been centered.  The MSCI EM equity index has moved to greater concentration in Asia, but these countries have stronger foreign reserves to protect form any currency crisis. The sector allocations have also changed over the last 20 years. EM is less dependent on energy and materials and more diversified across consumer companies and IT. This does not mean less sensitivity to a global slowdown. It does mean the points of risk are different.

Gross public debt has increased, but the growth has come from domestic public debt and not external public debt. FX reserves as percentage of GDP have increased significantly and are almost double levels from 2001. Greater reserves provide countries greater protection for their currencies if there is a crisis. 

We are worried about EM exposures. Fed rate increases have a spillover across global financial markets; however, EM financial markets may be more resilient than the environment of the 1990's.