Emerging markets (EM) are breathing a sigh of relief over the US Federal Reserve’s decision this past week to back down from aggressive interest rate increases, an industry expert said.

The dollar’s strength has also stalled providing another measure of respite for the emerging markets, which until very recently had been unloved and under-owned by global investors, explained Gary Dugan, chief investment officer at Emirates NBD, in the bank’s Wealth Management report.

Central bankers the world over appear ready to ease policy still further. The central banks of Norway and Indonesia cut rates last week and China, New Zealand, India, Taiwan, Malaysia and Thailand are expected to cut interest rates in the coming months.

The conditions have built for some outperformance by emerging market assets over developed markets. With central banks around the world maintaining, if not increasing the easiness of monetary conditions, emerging markets should see investor interest build. Much of the previous sell-off of emerging market assets was the concern over the possibility of a significant tightening of US monetary policy.

 Emerging market assets are under-owned by international investors. Institutional investors have run scared of the markets with weightings in emerging markets running at the lowest levels since 2006, according to a survey by Bank of America Merrill Lynch. It is only in recent weeks that the net selling of emerging market equities has subsided. March has marked the first month when every Asian country, for example, has seen net inflows into their respective equity and bond markets. Indicators of retail flows into emerging market debt funds turned positive after thirty-four consecutive weeks of outflows. We expect net inflows to continue lending itself to some good absolute gains from emerging market assets.

 The current cheap level of valuations in the emerging markets also favours adding to positions. The 12 month forward P/E multiple of the emerging market block is just 10.9x versus 14.8x for the developed markets.

Central bankers remain in a fix. The Fed last week significantly shifted their perspective on the need for interest rate increases in 2016. Whereas much of their previous talk was about how well the US economy was coming together and, therefore, a need to press on with rate increases. The Bank of Japan did nothing for fear of upsetting someone, but Bank of Japan Chairman Mr. Kuroda was quoted as saying that there could be a need to cut interest rates to -50bps in the future. Meanwhile, the ECB who the previous week had eased policy rates and added to quantitative easing saw some of the good work unwound as the euro appreciated materially against the dollar.

 The Federal Reserve's policy-making meeting delivered a dovish surprise to the market by sounding much more reluctant to raise interest rates. The 'dots' that show where members of the committee believe rates will be at the end of the year fell materially. Whereas at the end of last year the average vote was for rates to rise four times this year, that has fallen to just two rate increases. Also, for 2017, the forecast has come down from around 2.5 per cent to 2.0 per cent. Inflation was played down as a problem. Fed Chairperson, Janet Yellen, in the press conference afterwards talked more about long-term inflation pressures rather than immediate concerns that inflation could take off. Again this appears to be a significant shift from previous messaging.


The spike in the gold price from $1228 to $1264 as the Fed announced its more dovish tone was very telling. It suggests that the Fed has lost some credibility in the eyes of the market, and hence investors are looking for more credible currencies. With central banks likely to push interest rates further into negative territory analysts are expecting more demand for gold and hence higher prices.

 In a new book “The New Case for Gold” – by Jim Rickards he promotes what he believes a new modern day angle on why investors should own gold. The argument runs that holdings of equities, bonds, and mutual funds are all digital assets. They appear on a statement but are not typically available in physical form. Given the concerns of cyber-attacks on the global financial system, it would be prudent to hold a greater percentage of your wealth in physical assets such as gold. He believes that gold will eventually go to $10,000 an ounce.

 The decision making of central bankers still appears more constructive for bonds rather than equities. The reason we are getting looser than expected monetary conditions is that growth remains weak and unconvincing. Poor growth is not good for corporate profits and undermines equity market valuations. Analysts have downgraded their projected earnings growth in most markets for 2016 to low single digits. With the disappointing economic growth at the moment, the risks on earnings forecasts remain to the downside.

For the moment, the equity market has reacted positively. The knee-jerk reaction is that the Fed has taken away some of the risks of higher rates, hence the short squeeze on the market will continue. However, it will also eventually dawn on the market that the reason the Fed is less minded to raising rates is that there is still a lack of growth and persistent inflation, hence corporate profits growth remains under pressure. First-quarter earnings for the S&P 500 are expected to fall by around 5-7 per cent year-on-year and full- year profits are expected to be up less than 5 per cent, similarly in the Eurozone.

Central bank policy-making remains constructive for bond markets. US 10-year government bond yields fell smartly to around 1.90 per cent from just below 2.0 per cent, as the market took the view that further Fed interest rates increases would be slow to emerge. Two-year Treasury yields dropped 10bps to 0.86 per cent. Given the current bias of US, Eurozone and Japanese monetary policy-making we expect yields to remain biased lower rather than higher. Our preference in developed markets is for investment grade bonds and selective purchases of high-yield bonds, particularly in the Eurozone.

Talk is cheap but, at least, it can be put to good effect in the oil market. The past week has seen a good measure of talk about a meeting of OPEC and non-OPEC oil producers to potentially formally agree to freeze production. The Brent oil prices has spiked to $41.20 having at one stage hit $42.50. According to reports, the group of countries is due to come together on April 17 in Doha. The spot price of crude has risen 30 per cent since the freezing of production was first mentioned.

There a few things to bear in mind about the medium-term outlook for oil. The market needs to see production cuts to bring supply and demand forecasts back into better balance. Extra Iranian oil production at 500,000 barrels a day and a 100,000 barrels from Brazil is likely to weigh on prices. Also producers remain significantly under-hedged on their future production. Should oil spike to say $50, we could expect a significant number of producers to attempt to hedge the price of future production thus capping the spot price.

Chinese equities have established a good base in recent weeks and look set for further absolute gains. Chinese asset markets continue to get help from the policy makers. The past week saw further announcements for China’s government on initiatives to support growth and on structural changes in the economy. The Chinese government also indicated they wished to reduce leverage ratios of companies by swapping their debt for equity, while continuing to develop the capital markets and relax foreign investors' entry into China's markets. While the leadership acknowledged the need to reduce overcapacity in some sectors, they want to avoid large-scale job cuts by promoting new enterprises.

 In local markets the Egyptian central bank surprised by increasing interest rates by 150bps, more than expected. After the recent 13 per cent devaluation of the Egyptian pound the Central Bank was keen to stabilise the currency through the bold increase in interest rates. The equity markets have taken the policy measures as a significant positive move with a 31 per cent rise in the EGX 30 Index since the low in late January. The rise in the market was on large volume, which suggests that this time the central bank has generated a good level of confidence with its latest actions.

Emerging market risk assets staged a rally following Yellen’s dovish comments, alongside revised forward projections on policy rates. The Bank of Russia held its policy rate unchanged at 11.0 per cent, as widely expected. However, the statement was considerably more hawkish than what markets had assumed. The Central Bank of Turkey is to announce its policy rate decision this Thursday.

On the new issuance front, Dubai Islamic Bank is meeting fixed income investors tomorrow in London for a potential sukuk transaction (senior, unsecured). Indonesia, following meetings with investors, is set to announce initial price guidance on a sukuk deal early this week.

“We anticipate a 10-year sukuk transaction with our pricing assumption close to 300bps above benchmark,” Dugan said. – TradeArabia News Service