EM Fixed Income: Is the coast clear after the Fed?

Ben Ramsey (0:03)

Hello, and welcome to our At Any Rate, Emerging Markets Focus Podcast, a place for us to discuss recent developments and key issues of focus in the emerging markets fixed income asset class.

I'm Ben Ramsey, Head of EM Sovereign Credit Strategy here at JP. Morgan. And I'm joined today by Anezka Christovova, Head of EMEA EM and Latam Local Market Strategy, and Mike Harrison, Senior EMEA EM Local Market Strategist, both at JP. Morgan. Anezka, Mike, thanks for joining.

Anezka Christovova (0:29)

Hi, Ben. Nice to be here.

Michael Harrison (0:31)

Hey, Ben. Great to be here.

Ben Ramsey (0:33)

Great. So guys, we're recording this podcast on an interesting day for markets. The day after we got the first Fed hike since 2023, the first move of the year after the Fed had been on hold since last December, and it's obviously the first move under new Fed chair wars. So this move was widely expected after the hot US August CPI print last week, and that had followed a pretty strong August labor market report.

And this alongside this really pretty sharp march higher in crude oil prices since the end of August had that, of course, driven by what we've seen in more intensified conflict again in the Gulf region. And all that in this, again, that context effectively really shot up US and core rates, you know, putting those markets under really strong pressure. We saw the 10-year treasury moving rapidly up through 5% for the first time in almost 20 years. So now coming in today's session, which I noted could be potentially quite interesting, we're seeing that the realization of that Fed hike yesterday, even though it was widely expected, as I mentioned, seems to be at least initially a stabilizing factor for markets. Of course, we were also seeing oil prices ease a little bit today as the market's kind of gauging the supply constraints in the Middle East. But in any case, the US 10-year is back below 5%. We've seen some flattening in the long end. The dollar, which had sort of knee-jerked stronger after the Fed, is giving back some of those gains and risk assets. Among that, I would include EM credit is opening up with a firmer tone. So that's how I'd paint the picture here. Anezka, let me open this up to you. What do you make of the Fed's decision from your side and this initial market reaction?

How in this context are you thinking about EM local markets?

Anezka Christovova (2:34)

Thanks, Anezka, as you outlined, so the Fed has hiked. Most commentators, including us, have interpreted the decision as a little bit more hawkish than expected. I think one element here is that the Fed really hasn't communicated as much as in previous times in history. So we still had that little bit of uncertainty if they are really going to deliver. So that's one aspect, that they actually delivered a unanimous decision. And obviously there were then comments in the press conference and the dots changes, so that all combined in a direction, in a hawkish direction. Now, most asset classes, our colleagues here at JP. Morgan have focused on that being a positive for the market in terms of credibility. And even you mentioned the long end of the US yield curve. Now for us in emerging markets, FED credibility is a double-edged sword, I would say.

Because we have to some extent a comparative class to US assets. So actually for us, if the FED was less credible, my conjecture would be we would have traded even better.

So it depends a little bit, some nuances there between rates and effects. But if the FED was not credible, actually as a comparative asset class, we would have probably gained more versus the dollar, not less. Now, having a hawkish FED hiking, I would say on balance is negative for EM, mainly through the EM FX channel.

But what we have to discuss here is both the degree of that, what is the degree of that negative impact, and second, whether we might be already pricing it already, whether we've already seen the peak effect of that. Now, on the degree, we've already discussed that on this podcast before.

And I think the degree at this time is just smaller than in previous historical episodes. I think the degree kind of comes down to variables, like the balance of payments, positioning, real yields in EM, and the growth backdrop that is quite synchronized right now. So I think that decreases the degree of sensitivity. The second important question is, have we seen the peak pricing already? Now, that's always a difficult question to answer. We knew the answer to that with complete certainty. It will be very easy to trace. But in my own mind, I always thought that pricing total of four hikes for the Fed would be the peak pricing simply given what would it mean for how far is the Fed going to deliver above neutral rates, how much the economy needs tightening, also taking into account what our US economics are writing. I think that's an important point to think through if this kind of pricing for the Fed is now sort of peak for the data that we have seen.