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Fed cuts, China stimulates, EM capital flows reignite

EHSAN KHOMAN
Head of Commodities, ESG and
Emerging Markets Research –
EMEA
DIFC Branch – Dubai
T:+971 (4)387 5033
E: ehsan.khoman@ae.mufg.jp

 

SOOJIN KIM
Research Analyst
DIFC Branch – Dubai
T: +44(4)387 5031
E: soojin.kim@ae.mufg.jp

 

LEE HARDMAN
Senior Currency Analyst
Global Markets Research
Global Markets Division for EMEA
T: +44(0)20 577 1968
E: lee.hardman@uk.mufg.jp

 

MUFG Bank, Ltd.
A member of MUFG, a global financial group

Macro focus

The Federal Reserve has announced a 50bps cut to the federal funds rate, a move that is expected to have a significant impact on capital flows to EMs. The cut, combined with the slew of easing measures announced by the People’s Bank of China (PBoC) last week as well as the surprise economy-focused September Chinese Politburo meeting, sets the stage for a substantial shift in global capital allocation towards the EM space. According to IIF data, despite volatility in the market in August portfolio flows into EMs stood at a benign USD30.9bn with investors pricing in Fed cuts with positioning across EM debt. With the commencement of the Fed easing cycle this month, alongside less piecemeal Chinese stimulus, EM capital flows are set to reignite. However, the effects on EMs will be diverse and nuanced. While the widening interest rate differential between the US and EMs could draw increased capital into EM assets, particularly local currency bonds and equities, the response of EM currencies will be a critical factor to watch. Beyond currency impacts, the influx of capital can also bring challenges, such as heightened market volatility and the potential for asset bubbles, necessitating careful financial management and regulatory oversight. As the Fed’s rate cuts continue to influence global capital allocation, the dynamics of financial flows will play a pivotal role in shaping the financial landscape of EMs.

FX views

Against the backdrop of Fed easing and lower oil prices, unexpected China stimulus became the cherry on top. Have we finally arrived in the valley of the USD smile? While the broad narrative is that a global soft landing combined with Fed easing (if realised) would eventually result in broad USD weakness, the path to get to that destination at least on this side of the US elections could be shaky. From an EM perspective, Golden Week came early in Chinese markets as Chinese authorities showed some urgency in responding to weak domestic demand and depressed local asset markets with a slew of policy initiatives. Ultimately, we do not view that the CNY is likely to be the best expression of renewed China optimism–Chinese stocks, and to a lesser extent, other China related-currencies in EM (such as KRW) may be more responsive.

Week in review

The National Bank of Hungary (MNB) cut rates by 25bps to 6.50% in line with our forecast (as well as consensus) expectations. The Czech National Bank (CNB) lowered its key policy rate by 25bps to 4.25%, in line with our (and consensus) expectations. In Middle East, Moody’s downgraded Israel by two notches from A2 to Baa1 (negative) amid rising costs of conflict. Headline inflation in Qatar printed at 1.1% y/y for August but continues to be characterised by volatility. Dubai inflation came in at 3.4% y/y in August, up a tick up from 3.3% y/y in July. Finally, China’s seemingly breaks away from its previous piecemeal-style of policy easing and provide a sizable dose of policy stimulus that the market has long been hoping for.

Week ahead

In the week ahead, there will be rates meetings in Poland (MUFG and consensus: on hold at 5.75%) and Romania (MUFG and consensus: on hold at 6.50%). We also will get inflation data in Turkey for September (MUFG: 48.6% y/y; consensus: 48.3% y/y). Elsewhere, while these easing measures should be enough to catalyse a policy-induced equity rally and help support the real economy, we believe more demand-side easing measures, especially on the fiscal front (which markets remain focused on), will be necessary to drive a more significant upside move in equities and improve China’s challenging growth outlook.

Forecasts at a glance

Growth across the EM universe is set to stabilise as domestic fundamentals offset external drags, with some rotation from the largest to smaller EMs. Inflation and interest rates are both “over the hump” – disinflation is progressing, and the decline in rates will continue and broaden for the remainder of 2024.

Core indicators

The latest weekly IIF flow data signalled that EM securities witnessed USD11.1bn of inflows in the week ending 27 September. We reiterate that the relationship between EM currencies and Fed decisions are crucial – higher rates normally strengthens the US dollar, diminishing the appeal of EM currencies, which can lead to capital outflows and increased borrowing costs for EM.