Emerging market equities rising
It has been considered normal for emerging markets to witness capital outflows when the US hikes rates. The taper tantrum incident of 2013, when then Federal Reserve Chairman Ben Bernanke had indicated the possibility of monetary tightening, became a nightmare for emerging markets which saw currencies plunging and investors fleeing for cover.
However, stocks from developing countries were seen rejoicing when the US Fed hiked rates by 25 basis points on March 15. The Vanguard FTSE Emerging Markets ETF (VWO) rose 2.3% on March 15 from a day ago. It continued trading higher on the next day.
Given that the Federal Reserve has been hiking rates since December 2015, with the March hike marking the third rate hike in its current rate tightening cycle, is this behavior by emerging markets an anomaly?
Not quite so?
Let’s look back in time a bit.
The graph above shows the movement in the iShares MSCI Emerging Markets ETF (EEM) during the last rate tightening cycle of the Fed. The central bank had begun raising the federal funds rate from June 30, 2004. Prior to the 25 basis point hike on that date, the rate had stood at 1%. Two years and 17 rate hikes later, the rate had stood at 5.25% with the last hike effected on June 29, 2006.
During the aforementioned period, EEM did quite well for itself. With the benefit of hindsight, we can see that although in the immediate aftermath of a rate hike in the US emerging market equities have declined, over an entire cycle they seem to have done quite well.
Going further back to earlier rate tightening cycles may not be very useful as both the US and emerging markets have evolved considerably since those times, thus making the comparisons to that time less useful today.
Apart from emerging market stocks, another asset class which has been historically effected by rate hikes in the US is currency. Let’s look at how emerging market currencies have reacted to the latest rate hike by the Fed in the next article.