Are emerging markets back?

Katie Martin (0:00)

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One asset class that normally just loves a drop in US interest rates is emerging markets, and we're seeing a little bit of it again now. Lower US rates generally mean lower US bond yields, and that makes higher yielding emerging market government bonds really stand out. Plus, the US economy is in pretty good shape, and we have a load of stimulus that just landed from China. So, today on the show we're asking, is EM back? This is Unhedged, the markets and finance podcast from the Financial Times and Pushkin. I'm Katie Martin, a markets economist here at FT Towers in London, and I'm joined again down the line from New York City by that bright young thing, Aiden Reiter.

Aiden Reiter (1:12)

Good morning.

Katie Martin (1:13)

How are you doing, Aiden?

Aiden Reiter (1:14)

I'm good. I was just home for the Jewish holidays, and my mother said to me, you know, that Katie has the most lovely voice.

Katie Martin (1:23)

Team Aiden's mom. I like that. So we're team Aiden's mom, but we're also team EM, right? Like, why does EM, why do emerging markets like it when the US is carrying rates?

Aiden Reiter (1:35)

Yeah. Well, the US is the standard of the world. So when you look at emerging market debt or any other government's debt, you're essentially looking at its yield relative to the United States. So if the US is starting to come down, that makes those emerging markets that much more special, right? They look much better in comparison because US rates are lower. Also, emerging markets tend to hike way higher, and in this cycle, they've actually hiked faster than the US. So they had their rates come up way before the US and other large economies.

Katie Martin (2:02)

Yeah. This is the big thing about EM, right? So as soon as we came through the immediate shock of COVID and supply chain started snarling up and inflation started picking up, all the kind of big Western central banks effectively, look at the Fed, the Bank of England, the European Central Bank, they were like, this is just transitory, we're going to just sit on our hands for a little bit and see how this turns out. The emerging markets were like, no, we've seen this movie before and we are not having it. So they hiked quickly and hard.

Aiden Reiter (2:30)

Hard, yeah. So Brazil or Mexico, they had their rates above 10 percent as opposed to in the three to five range in the EU, the US, and the UK. So that makes them really appealing if you want to put your money there. But everybody loves the dollar. So when US rates are high, even if they're not as high as emerging markets, it just has the effect of sucking capital out of the emerging world.

Katie Martin (2:51)

So Aiden, let's talk about what does emerging markets mean? Because it's a bit of a sort of, it's a bit of a squidgy term and generally people take it to mean anything that's not kind of core, Europe, US, Canada, Japan, Australia and stuff. But it's not a terribly useful term.

Aiden Reiter (3:13)

No. As you said, it's kind of everyone accepts the big economies that you just named. And because of that, it's just like this really broad index that covers economies as disparate as Brazil and South Korea. South Korea has been quote unquote emerging forever, and they're kind of an advanced economy, but they're sometimes included in some of these indexes and conversations about emerging markets. So it just generally means like you are not Europe or, you're not Western Europe, I should say, or the US or Canada. And at some point in the last 50 years, you were a quote unquote developing economy, and you are not unabashedly a developed economy at this point.

Katie Martin (3:47)

Listeners, you're going to have to bear with us here. There is just a bit of a kind of, there are gray areas all over this definition, but we're talking about economies that are not like major developed economies, G7 economies, G10. So I pulled some numbers actually before I came to record this. And so the MSCI Emerging Markets Index of stocks is up about 14, 15% in the past five years, right? That's not terrible. But you compare that to the MSCI World Index, and there you're looking at about 70%.