Emerging-Market Assets Climb as Softer US Jobs Data and Oil Drop Cool Fed Hike Bets

What happened

Emerging-market assets, such as stocks and currencies, saw an increase in value, driven by two primary factors: US jobs data that came in weaker than anticipated and a subsequent drop in oil prices. This confluence of events contributed to a reduction in expectations for aggressive interest rate hikes by the Federal Reserve (Fed).

Why it matters

The perception that the Fed may adopt a less aggressive stance on interest rates is crucial for emerging markets. Higher US interest rates tend to attract capital towards the dollar and US Treasuries, making emerging market assets less attractive and more expensive to finance. The expectation of a less intense monetary tightening cycle alleviates this pressure, improving investor sentiment and encouraging capital flows into developing economies. The decline in oil prices is also a positive factor for many energy-importing emerging countries, as it reduces costs and inflationary pressures.

Market impact

• Interest rates and bonds: The expectation of a less aggressive Fed tends to lead to a decrease in US Treasury yields, as demand for these bonds may diminish in a scenario of less need for protection against inflation and higher rates. This could create room for emerging market bond yields to also adjust downwards, albeit to a lesser extent, or for the spread relative to Treasuries to narrow, making them more attractive.
• Dollar and exchange rates: The dollar tends to weaken against other currencies, especially those of emerging markets. A less hawkish Fed implies a smaller interest rate differential in favor of the dollar, reducing its appeal as a safe haven and favoring the appreciation of developing country currencies, which benefit from increased risk appetite.
• Equities: Emerging market stock exchanges tend to rise. Lower US interest rate pressure and a weaker dollar improve financing conditions and the investment environment for companies in these countries, in addition to boosting foreign capital flows into their stocks.
• Commodities: The decline in oil prices, as mentioned in the news, can have a mixed impact. While beneficial for importers, it may weigh on oil exporters. However, improved global sentiment and the expectation of a soft landing for the global economy (less impact from high interest rates) could support other commodities.
• Brazil: The Brazilian market, as part of emerging markets, tends to benefit. The real may appreciate against the dollar, and the Ibovespa may register gains, driven by foreign capital flows and improved global sentiment towards risk assets. Brazilian interest rate futures may also react with a fall, reflecting less external pressure and the possibility of a more favorable domestic interest rate cutting cycle.

What to watch

Upcoming US inflation and employment data will be crucial to confirm or invalidate the reading of a less aggressive Fed. Any sign of unexpected resilience in the US economy or a rebound in inflation could quickly reverse current sentiment. Furthermore, communications from Fed members and minutes from upcoming meetings will be important for calibrating monetary policy expectations.

Scenarios

Base Scenario: The Fed maintains a more cautious stance, with US economic data confirming a gradual cooling. This sustains capital flows to emerging markets and the appreciation of their assets. Risk Scenario: Future US data surprises with strength, or inflation shows persistence, forcing the Fed to resume a more aggressive rhetoric. This would reverse optimism, leading to capital outflows from emerging markets and depreciation of their assets.

Original source: Bloomberg Markets. For information only, not investment advice.