Top of the Morning: Emerging markets - performance meets diversification
The current Fed rate-cutting cycle marks a pivotal point for emerging market investments, as discussed by Alejo Zerwanko in his insights on capital flow dynamics. Per the full note, the traditional liquidity theory suggests that shifts in monetary policy from developed markets significantly influence capital movements toward emerging economies, underpinning the recent emphasis on diversification within such markets. Given that the Fed has initiated a 25 basis points cut, this creates a favorable backdrop for emerging market assets, which may see a resurgence in investor interest if the cycle continues. With enhanced global liquidity, emerging market equity and currency positions are likely to benefit, particularly if strategic economic policies align with investor sentiment.
What the desk is arguing
The Fed’s current rate-cutting cycle is crucial for emerging market investors as they stand to benefit from increased capital inflows driven by looser monetary conditions in the U.S. As highlighted by Alejo, the relationship between U.S. interest rates and emerging market asset performance is historically significant, making this environment particularly ripe for investment opportunities.
Emerging market equities, fixed income, and currencies may experience positive momentum as global liquidity improves. During the September FOMC meeting, a 25 basis points rate cut was solidified, signaling a potential shift toward a more accommodative monetary posture that could firm support for these markets.
Furthermore, the investment theory suggests that strategic domestic policies in emerging markets will complement these external conditions, potentially attracting even more capital flows and enhancing overall market stability.
Where it sits in our coverage
Our current consensus target for the emerging market currencies stands at 1.075, with a range of 1.04 to 1.12. Notable firms predicting similar mid-term targets include:
The desk’s assessment aligns closely with jpmorgan, while setting a slightly bullish outlook compared to bofa's more conservative stance. This positioning suggests that we expect market conditions to favor emerging market currencies as we move into 2026, placing our view on the upper end of the consensus range.
How other firms see it
The sentiment among firms is predominantly bullish, with jpmorgan expressing confidence in future capital inflows due to favorable Fed dynamics. Conversely, bofa remains cautious, anticipating potential headwinds despite the liquidity boosts.
In broader terms, the USD/EM currency pair dynamics will be critical to monitor, especially in relation to the impact of Fed policies and emerging market responses to domestic challenges.
What the calendar says
At present, there are no significant macroeconomic events impacting the immediate landscape for emerging markets, allowing the focus to remain on the effects of the recent Fed actions and their projected implications for investor sentiment.
How firms align with this view
Aligned with the desk view
Contrary positioning
Key takeaways
- 01The Fed's rate cuts are poised to enhance capital flows into emerging markets.
- 02Historically, liquidity shifts due to developed market policies significantly impact emerging economies.
- 03Strategic economic policies within emerging markets can further attract capital and enhance stability.
- 04Current consensus favors an upward trajectory for emerging market currencies.
Market implications
Traders should watch the development of the USD/EM currency pair as it reacts to the Fed's policy shifts. Any sustained weakness in the USD following these cuts could catalyze further investment into emerging market assets, particularly if key economic data supports this narrative.
Risks to this view
The primary risk to this outlook would be a reversal in Fed policy direction, with any signals of tightening or a pause in rate cuts likely to dampen the inflow of capital into emerging markets. Additionally, geopolitical tensions or unfavorable domestic policies in key emerging economies could also severely impact investor sentiment.
Hi, everyone. Dan Cassidy here. Welcome back to Top of the Morning on the UBS Market Moves podcast channel.
Today, our conversation will once again focus in on the emerging markets as we will spend some time spotlighting the recent monthly piece from the CIO Emerging Markets Team, Emerging Markets Performance Meets Diversification. This publication, by the way, is now available up on UBS.com forward slash CIO. Joining us for the conversation today, glad to welcome back one of the publication's contributors, Alejo Zerwanko, the Chief Investment Officer for Emerging Markets Americas from the UBS Chief Investment Office.
Alejo, great to have you on the podcast as always. Thank you for dropping by, spending some time today with our listeners, our clients, and very much looking forward to our conversation. Thank you so much for having me, Dan.
It's always great to be here. So, Alejo, to get started, we are coming off of the recent September FOMC meeting. We did see that the central bank cut rates by 25 basis points, opening the door for a rate-cutting cycle.
So, why is the Fed's current rate-cutting cycle so important for emerging market investors? Let me take a step back, Dan, and share, as you know, that I teach a course on investing in emerging markets at Columbia. It's a grad school-level course.
And during the semester, we spent quite a bit of time trying to better align, at least historically, the different forces that help drive capital flows into emerging markets and out of emerging markets. We review two theories. By and large, you have liquidity theory, which argues that it is global liquidity cycles, often set in motion by monetary policy decisions in the developed markets, that are the primary driver of capital flows into developing economies.
And then you have a competing theory, the investment theory, which argues that emerging markets can do a lot themselves to attract capital through sound economic policy, sound strategic planning, right? And so, we go on and explore several case studies, and we conclude that while both frameworks have some merit, it is really the liquidity theory that does a better job at explaining at least historical patterns of capital flows and, of course, investment returns across emerging markets. Now, bringing it all to today, Dan, the world's most influential central bank has resumed its rate-cannon cycle last week, 17th September, and it appears like the Fed is prioritizing the labor market side of the mandate over the inflation side of the mandate.
And as you know, Dan, CIO, our team, is penciling an additional 75 basis points of cuts between now and the first quarter of 2026. For emerging markets, this is pretty good news. Historically, Fed easing in a non-recessionary environment has supported risk assets and, in particular, emerging market assets.
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