The pace of future rate hikes in the US
We had seen the reaction of emerging markets to the FOMC statement released on December 14 in an earlier series. The more important aspect to focus on is the pace of future rate hikes in the US. We’ve reproduced the graph which lays out the projections of FOMC (Federal Open Market Committee) participants regarding the year-end level of the federal funds rate as released along with the December 2016 monetary policy statement. The graph is popularly known as the ‘dot-plot.’
Of the 17 members who participated, only one expected that the federal funds rate would stand above 2% by the end of 2017. At a rate of a 25 basis point hike per meeting, this translates to six rate hikes next year. Two members expected the rate to be between 0.75-1.0%, which means that these two expect only one more rate hike in the coming year. Meanwhile, 10 of the voting members expected the rate to be in the 1.0-1.5% range, translating into two to three rate hikes by the end of 2017.
Investing in emerging markets
Even in December 2015, when the FOMC had raised rates, the dot-plot had showed that up to four rate hikes could take place in 2016. However, we just saw one. Removing the two extremes of rate hike expectations, it is safe to assume that all things being the same, at least two rate hikes will be effected in 2017.
If this expectation turns out to be true, then emerging markets may not be negatively impacted much. However, given the higher risk that comes with investing in these nations, moderate risk-taking investors would do well to invest in broad-based emerging market funds like the iShares MSCI Emerging Markets ETF (EEM) and the Vanguard FTSE Emerging Markets ETF (VWO), among others. More adventurous investors can chose emerging markets whose dynamics work for them.
Investing in developed markets
Among developed markets, the US (IVV) looks better placed than any other market. The impact of Donald Trump will unfold only in the coming year, but the pace of economic growth, growing inflation, and tighter labor market conditions look promising. Given that inflation refuses to budge in Japan, and Brexit looming large on Europe, investors should be careful about the percentage of their equity portfolio that they invest in these geographies.