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Emerging Markets Await Federal Reserve Rate Hike in December

Notes From U.S. Central Bank Signal First Interest Rate Hike In A Decade

The U.S. central bank released the minutes from the October Federal Open Market Committee (FOMC) meeting on Wednesday, November 18, 2015. At its previous assembly, the Federal Reserve had kept the benchmark interest rate unchanged at 0.25 percent, but the statement published at the end of the meeting added that the possibility of raising interest rates at the December meeting is firmly on the table. The market had become increasingly frustrated with the Fed's lack of communication on the timing of the much-awaited ‘rate hike’ and welcomed a clear message pointing to the last meeting of the year.

Tighter monetary policy on the horizon

The notes from the October FOMC meeting were made available to investors two weeks after the actual gathering. For the most part, the minutes showed a large group of hawkish Fed members ready to start a monetary policy tightening cycle. There are still some members that are wary that hiking before the U.S. economy gathers momentum could put in jeopardy the pace of growth. The risk of waiting too long and a further credibility hit for the central bank are outweighing the risk of raising borrowing costs too early. The December FOMC was called a "live possibility" by Federal Reserve Chair Janet Yellen who testified before Congress two days after the October meeting.

The U.S. dollar did not extend its rally versus emerging market currencies after the minutes were published. The internal Fed debate signals many doubts regarding the state of the U.S. recovery and has the American dollar trading sideways. This means that while the Fed will most likely raise rates in December, it will then gradually raise them but at a slower rate than was at first forecasted, reducing the potential interest rate differential advantage for the dollar.

Emerging economies will overcome higher borrowing costs

Several emerging market policymakers have urged the Federal Reserve to stop talking about a rate hike and show some action. Central bankers from India, Indonesia, Mexico and Peru appear confident that their economies can overcome the effects of higher borrowing costs, but also thrive from higher American demands of emerging market goods.

Capital Economics Senior Emerging Markets Economist William Jackson wrote: "For all the talk of a collapse in emerging market growth since the summer, the Q3 GDP figures released so far provide little evidence of any significant emerging market slowdown."1

India stands above the rest of emerging markets

Emerging markets are not homogeneous. For every India there stands in contrast, economies such as Brazil, Russia and Ukraine that have hit new low points in 2015 as commodity prices have plummeted, although next year's projections are more optimistic for commodity producers around the world.

Emerging market economies with twin deficits continue to struggle and are more exposed to a high interest rate environment. The precarious state of the U.S. economic recovery means that the rise won't be sudden, which leaves governments with options on how to tackle higher borrowing costs. The search for higher yields is expected to drive investors to emerging markets en masse. While the U.S. rate normalization path might be started in December, it is now expected to take a more gradual pace going forward.

India’s economy is booming, and even with a hiked interest rate, there is still optimism that record growth will continue. Our Excel India Fund is the best vehicle for you to use in getting your money into the right companies. Our years of hands-on experience makes us the authority in investing in emerging markets.

 

1 Capital Economics "GDP figures show fears of EM slowdown overdone"

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