NEW YORK: Emerging markets are facing their demons as traders mull whether U.S. Federal Reserve interest rates will rise as high as 6 per cent, a level that could kick weaker countries when they're down, while diverging global growth paths and China's reopening might cushion some of the blow for the bigger ones.
Expectations for where the Fed's terminal rate would peak have been rising at breakneck speed: Markets are pricing in a 5.5per cent -5.75 per cent range for September, while the CME shows a near 50per cent chance for the band to hit 6per cent that month.
The scale and pace of the move makes for uncomfortable reading for investors in developing stocks, bonds and currencies that have often buckled under rising global rates.
"The current repricing risk in the Fed's terminal fed funds rate to perhaps 6per cent in a short period of time is in the context of (the) response to inflation running stubbornly well-above target in a weakening global GDP growth environment," Satyam Panday, chief emerging markets economist at S&P Global Ratings told Reuters.
"This mix is generally a net negative for emerging markets." Expectations for further Fed hikes had been for 25 basis point increments, but Fed Chair Jerome Powell on Tuesday brought Few expect a smooth ride for the remainder of the week, with the monthly U.S. jobs report for February providing markets with more evidence to chew over.
"Fed tightening towards 6per cent would firmly test historical 'pain thresholds' for emerging market assets," said UBS strategist Manik Narain in a note, predicting India's rupee, China's yuan and the Philippine and Chilean pesos could weaken as much as 5per cent if the Fed ramped up rates to 6per cent.
A recent Barclays analysis showed a 50 basis point Fed rate hike would increase interest rate volatility, which "would be more destabilizing initially, as it typically comes with EM FX underperformance, which could trigger a further leg up in EM rates." Analysts at JPMorgan expect the dollar to weaken once the terminal rate stabilizes, but a 50-basis point Fed hike "would be a regime-shift in favor of outsized USD-strength." _Reuters.
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