When the Fed cut by 50 bps on 18th Sep, emerging markets suddenly looked well poised to enter a golden run for investor flows. But now for following three reasons (in order of probabilities & impact) we believe EM flows might be adversely affected till end CY24: 1) Recent US macro data such as non-farm payrolls data, CPI & retail sales have surprised significantly on the upside in Oct. This implies US exceptionalism is here to stay. Fed might be forced to acknowledge this by as soon as Dec meet when their DOTS might again do a U-turn towards only 2-3 rate cuts in CY25 against Sep’s projected 4 rate cuts in CY24. Even the terminal rate might be shifted north of 3% in Dec DOTS. This does not bode well for EM assets. 2) We believe it is a strong possibility that Republicans might sweep 2024 elections across Senate, Congress as well as the President post. This implies a higher tariff regime & higher fiscal deficit in US. This in turn adversely affects global trade including EM exports to US, both goods & services. 3) The 3rd reason is a low probability event of Israel attacking Iran post US elections with the direct support of Trump & US forces. This implies higher geopolitical risk premium and higher crude which does not bode well for EM assets both equity & debt. If our view is correct, we expect to see CNH at 7.30 & MXN at 21 post US election results. But then both PBOC & Banxico could potentially step in with FX intervention around these levels (like the 2016 experience). For the same reasons we believe details of Chinese fiscal stimulus plans might be withheld till US election results are out. On FX hedges, MXN, CNY and KRW seem to be offering a relatively expensive hedge, likely reflecting markets' concerns about global goods trading. Hence position paring now is better than going into the event risk even with hedges on as hedge cost in most EM FX is anyways higher than MTM on existing investments.
