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The EMD countries set to thrive through Fed hikes

The EMD countries set to thrive through Fed hikes

Emerging market countries have anticipated the Fed action by front-loading issuance earlier in the year to benefit from more attractive financing levels, according to T Rowe Price’s Andrew Keirle.

Citywire + rated Keirle, who runs the T Rowe Emerging Local Markets Bond fund, said action taken by EM countries has ‘provided protection from potentially higher interest rates’.

'Emerging market debt has been remarkably resilient, considering in the past it has been heavily influenced by the Federal Reserve’s actions,' he said to sister site Citywire Selector.

'When assessing why the asset class is possibly behaving differently this time, the Fed has clearly telegraphed its plans to tighten monetary policy. This has given emerging market countries time to prepare.'

Keirle’s top country allocation in the fund is South Africa, with 11.4% exposed to the country. Despite this heavy weighting, Keirle highlighted Brazil, Columbia and Russia as being promising bets in EMD.

'While the Fed is hiking on the back of better growth and rising inflation, a number of emerging market countries with attractive real yields, like Brazil (8.6%), Colombia (5.4%), and Russia (5.3%), are in a disinflationary stage of their economic cycle.

‘This makes their local bond markets attractive even in the face of the Fed tightening monetary policy,' he said.

Improving landscape

Keirle said economic conditions across EMs have improved with countries making difficult adjustments and structural reforms, ensuring they are able to withstand slow, steady increases by the Fed.

'The Fed reiterated its ‘slow and steady’ plan by keeping its medium-term forecasts unchanged. While the Fed hiked - the terminal rate remained unchanged at 3%, keeping intact the positive picture for EM.

'Nonetheless, we are still mindful of the potential for short-term setbacks. EM has been rallying for several months, raising questions about how much longer it can last.

'In addition, EMs only passed the first Fed rate ‘hurdle’, while there are potentially two more interest rate hikes to come in 2017 which could provide a supportive backdrop for the US dollar.'

Keirle said the current backdrop makes it difficult for investors to see ‘meaningful’ and ‘broad appreciation’ of emerging market currencies against the dollar.

'It is important in the current climate to look for idiosyncratic stories that are less sensitive to Fed policy. Inflation divergence is key when reviewing the opportunity set within EM bonds.'

The T Rowe Emerging Local Markets Bond fund lost 5.94% in US dollar terms, over the three years to the end of March 2017. This compares with its Citywire-assigned benchmark, the Cust Benchm JP GBI-EM Diversified USD, which lost 7.69% over the same time period.

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