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Strong US data doesn’t disqualify other key risks, EM analysts, PMs warn

Stronger jobs growth data out of America sent US equities to all-time highs earlier this week, with some anticipating a more aggressive timetable for a US interest rate hike. EM analysts and portfolio managers caution that other significant risks are present and could complicate such a move.

Jul 12, 2016 // 12:39PM

The S&P 500 jumped from 2097.90 on close of trading July 7 to 2129.90 by close of trading on Friday July 8 on the back of strong nonfarm payroll data out of the United States.

Total nonfarm payroll employment increased by 287,000 in June after rising by just 11,000 (revised down from 38,000) in May, and the unemployment rate rose by 0.2% to 4.9%, the US Bureau of Labor Statistics reported last week. Average hourly wages were up by 2 cents to $25.61.

The S&P 500 jumped again on Monday 11 July to 2137.59 and peaked yesterday at 2141.91 before settling back down to 2137.04 at close of trading yesterday.

Strong growth out of the US has once again put a possible US rate hike back on the table for this year according to some analysts. Yesterday, Esther George, president of the Kansas City Fed, said interest rates are currently too low, and indicated that she is planning to vote for a rate hike at the next FOMC meeting in July.

Although fed fund futures are only pricing in a 4% probability of a rate hike in July, they are now pricing in a 29% probability of a rate hike by the end of the year, according to analysts at Standard Bank. Most analysts had expected a US rate rise to come in 2017 at the earliest.

Greg Saichin, Managing Director and CIO Global Emerging Markets Fixed Income at Allianz Global Investors Europe GmbH said that beyond the July window, unless the economy’s performance sees huge deviations, the Fed will have fewer reasons to be hawkish on a rate rise.

“It will take more convincing data for them to move in September,” he said. “Past that you have the US elections and given the uncertainty about that outcome the Fed has more incentives to keep an accommodative stance.”

This comes as some of the world’s largest central banks look set to embrace further monetary easing. The Bank of England, in response to market uncertainty catalysed by the UK’s Brexit vote, is expected to cut rates and set up another round of quantitative easing when BoE officials meet later this week, while the Bank of Japan is expected to ease monetary policy when they meet later in July.

“I am actually of the view that the US Federal Reserve should have hiked some time ago, in part because risk and volatility still remains. The Fed could have used the room to manoeuvre in the event it had to contain or address any shocks instead of keeping rates near zero,” said Regis Chatellier, a senior EM credit strategist at Societe Generale.

“Developed markets are arguably riskier than emerging markets at the moment, and with the decision to delay triggering Article 50 and the UK’s formal withdrawal from the European Union we may see much of that volatility continue.”

“What happens with Brexit and with China’s continued transformation is still a significant risk to all, including of course the US,” he added.

With many developed market debt assets yielding negatively emerging market debt has benefitted from strong inflows, which have been fairly resilient in the face of the Brexit vote. EMs received non-resident portfolio inflows of US$16.7bn in June, a big improvement over May, but shy of the 2010-2014 average of US$22bn, according to the IIF.

The impact of the Brexit vote was fairly minimal on EMs – which saw roughly US$210mn on “Brexit Friday” compared with the US$2.7bn lost on Aug. 24, 2015, when concerns about China triggered global market jitters, the organisation said. On the other hand, the vote did push developed market assets lower.

Chatellier explained that if the US economy continues to perform as well as it has the Fed will have little choice but to hike interest rates, but with inflation remaining close the 1.02% range seen in May, having dropped from 1.13% in April, there isn’t scope for an aggressive hike. Ultimately, given the spreads seen on EM bonds – in the sovereign space those tend to be in the 375bp range – we would need to see fairly aggressive hikes to see any serious impact on EM credit.

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