So here’s an interesting anti-taper tantrum take from Morgan Stanley. It’s no secret that Emerging Markets (EM) has had a heck of a run.
The question now is: what happens to that run if the Fed hikes? After all, the threat of EM outflows was the one of the main reasons the FOMC adopted the (in)famous “dovish relent” last September.
Well maybe, just maybe, the market knows the Fed is just hiking to prove it can. Which means no matter what happens on the short-end, the long-end is anchored. Anchored to basically zero. Here’s Morgan Stanley:
“Ironically and unlike previous occasions where markets discussed the prospects of higher US interest rates, we expect the USD to turn lower against high-yielding FX. Indeed, the current setup is in sharp contrast to what we saw in 2013 and 2015 when EMFX weakness was pronounced. There are a number of reasons for the contrast. First,high-yielding EMFX is particularly sensitive to the evolution of long-end US yields. With US bond yields likely staying muted, the incentive to liquidate the EM carry trade is low. Nominal and real yield differentials may remain attractive as US bond yields stay near current levels. Second, the aggregate current account deficit for high yield EM has turned into a surplus, suggesting the region is now capital self sufficient. Third, Emerging Markets
EM capital inflows,although slowing down from July highs,have remained positive.Fourth, EM-DM growth differentials have widened recently (Exhibit 7), reversing the contracting trend that had been in place since 2012.”
(Charts: Morgan Stanley)