© Bhanu Baweja
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I do think that the US will raise rates. We have pencilled in 25 basis points for December and other UBS economists are expecting another four hikes next year, so that is above consensus. However, we are not looking for a crisis in the EM. The difference between the 1990s and emerging markets today is that EM does not have as many Dollar liabilities as it used to in the 1990s. As a result, while EM will suffer and underperform developed markets, I do not believe that EM will see a financial crisis, certainly not in a general sense. To my mind, there may be a few countries that see financing pressures increase tremendously, Turkey being one of them; however, we do not expect that is going to be an issue EM-wide at all. Nevertheless, that should not make you think that I am bullish on EM, I have been bearish for a long time and I still see that in 2016 EM will underperform developed markets. Still, a crisis looks very different from the kind of underperformance that we have seen and I do not think that a crisis is likely.
What performance do you expect to see from the emerging currencies in case the Fed hikes on its next meeting in December and what currency in the emerging market might be hit the most by the Fed's decision?
We are expecting 5-7% losses in EM currencies against the Dollar within the next 12 months, through the time that the Fed hikes. That is significantly better than the kind of losses that we have seen in the previous 12 months. Thus, to some extent this idea of Fed hiking rates is in the price in EM, but we do not think that EM will be able rally in absolute zero sell-off, perhaps by less than it has sold off in the past few years.
The currencies seen most vulnerable to us are the currencies that are backed by economies which are levered in Dollars. However, they do not benefit from the US economy recovering; they have borrowed from the US but have very little to do with the US growth. In my book, those currencies are South Africa, Turkey, Indonesia, and to some extent Brazil.
While sentiment towards emerging markets may have improved somewhat over the past few months, it still takes a brave investor to be bullish about EMs. What other factors besides the Fed weigh on traders' sentiment towards the EM?
The fact that EM growth remains very poor along with the fact that global trade remains very poor, as well as the fact that commodity prices, which is linked to Chinese growth, and particularly to Chinese investment, are still under pressure – these are the factors that, to my mind, will mean that EM suffers more than developed markets. Hence, it is not just the Fed: the potential for the Fed hiking rates has been a problem for EM for some time. However, since 2013 the EM, because its own balance sheets have deteriorated and its own macro risk has increased, has suffered intrinsic issues that have meant that EM is underperforming even more, particularly in 2015. Hence, EM's problems are not just about the Fed cycle. In fact, I would say the Fed cycle is a smaller problem than the slowdown in global trade or the utter decline in Chinese imports, which is impacting commodities. In my opinion, while the Fed is not irrelevant, I would not suggest that this is the case; thus, that it is not EM's biggest issue. Emerging markets have lived with higher rates in the past, but at that time EM was also growing quite strongly. The problem today is that rates in the US may slowly begin to rise, but EM does not have the inflection point on growth.