FOMC meeting presents potential turning point for emerging market debt

As the Federal Open Markets Committee meets to discuss the future direction of its monetary policy, Schroders fund manager and Co-head of Emerging Markets Debt Relative James Barrineau discusses the potential opportunities a tightening cycle presents for investors.


James Barrineau

James Barrineau

Head of Emerging Markets Debt Relative

Whatever the eventual outcome of the Federal Open Markets Committee (FOMC) meeting this week, once we jump the initial tightening hurdle talk will immediately turn towards the length of the tightening cycle.

This is, in our view, more pertinent than the question of whether the Federal Reserve (Fed) will remove the word "patient" from the wording of its commentary regarding its approach to normalising monetary policy.

The Fed has been at pains to suggest a shallow cycle; one that will not involve consecutive meeting hikes. This would be more supportive for emerging market debt, and the economic outlook strongly supports the view.

Outside of the strength in US employment, economic data has broadly disappointed. We believe that the market weakness in emerging market debt is laying the ground for better times in the future; provided our thesis is correct that the Fed will be slow in tightening rates.

A case of history repeating itself?

History is certainly on our side, though as ever, it may be difficult for investors to remember that far back. Essentially, well-telegraphed cycles have eventually led to emerging market debt rallies, once markets reflect the initial risks of tighter policy.

Nevertheless, the divergence of debt opportunities according to country remains profound. There are a number of emerging market countries that face difficulties, making a sell decision an easy call.

Emerging market opportunities

Brazil is one such country, with weak growth, high inflation, and questions over the ability to implement fiscal reform. This has led to poor sentiment despite interest rates approaching 13%.

Turkey, with a looming election and increasing political influence in markets, is another.

The next few weeks could prove a turning point in stimulating depressed emerging market debt valuations.

Russia has been a better performer and represents an overweight for our portfolios. The central bank this week has cut rates, but the easing was at best in line with market expectations, if not a bit conservative. The massive fall in the rouble, and widespread underexposure to the currency, are helping to boost the effectiveness of the rate cuts as volatility subsides steadily.

Mexico represents our other main overweight. The government took a step to steady currency volatility this week, and we expect the central bank to hike rates as soon as the Fed does. Even in a weak market, Mexico should outperform the rest of the asset class.

Turning point approaches

Provided investors are attuned to the structural and fundamental differences within emerging markets, we believe that the next few weeks could prove a turning point in stimulating depressed emerging market debt valuations.