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Troubled emerging markets face fresh pain from U.S. rate hike

By Karin Strohecker and Jorgelina do Rosario

LONDON (Reuters) – The prospect of U.S. interest rates climbing to levels last seen before the onset of the Global Financial Crisis adds to the global financial crisis. There is new hope. Emerging economies are struggling to recover from the Covid-19 pandemic, dealing with rampant inflation and facing capital flight.

Many past emerging market crises have been associated with a stronger dollar and rising U.S. interest rates, forcing developing countries into tightening monetary policy to prop up their currencies and fend off inflationary pressures, pushing up U.S. dollar-denominated The cost of servicing the debt.

This time, there are some differences: emerging central banks have been leaders versus laggards in tightening cycles, with policymakers in many regions starting to raise rates as early as the summer 2021.

However, with major central banks now joining the inflation war, the market is predicting the Fed will raise interest rates to 4.6% by March 2023 – a move that will increase heat, especially in smaller, higher-risk developing economies.

This is a sharp and rapid change from a few months ago 14 months ago, when the Fed forecast

No rate hikes.

“This year has been a perfect storm,” said Damien Buchet, chief information officer at Finisterre Capital.

“The Federal Reserve and the European Central Bank (ECB) are behind the curve we need to move towards tightening financial conditions.”

Some of the world’s poorest countries expect Debt service payments will rise to 69 billion 2024 – the highest level in the current decade, according to a recent report.

It has been a tough year for financial markets as countries grapple with a potential recession and energy shock following the Ukraine war, but assets in some emerging countries have been disproportionately hit.

Equities in developing countries are down about 69% this year, underperforming major developed benchmarks in Europe and the US, which have fallen by 14%. Returns in hard currency and local currency fixed income were both deep in the red, while currencies – notably Latin America – also tumbled.


Emerging market assets suffered a record outflow triggered by Russia on February 2, according to the Institute of International Finance’s Capital Flow Tracker 14 invaded Ukraine. Capital outflows from emerging markets outside China only ended in August, the IIF said in September, similar to what happened during the 2013 tapering scare.

Manik Narain, head of emerging markets strategy at UBS, said: “The fate of emerging markets continues to largely depend on the actions of the Federal Reserve.”

Major emerging market central banks

raising interest rates by nearly 6, 000 basis points , Reuters calculations show, their inflation struggle Will continue until the end of August.

But tightening monetary policy also dampens growth. The actions of the Federal Reserve and other major central banks have prompted early warnings from international officials and analysts that higher interest rates in currencies such as the dollar and the euro could severely tighten global financial conditions, leading to a global recession.

Developing central banks find themselves at different stages of a tightening cycle, said Claudia Calich, head of emerging markets debt at M&G Investments.

“If you look at the forward and implied curves in some Latin American countries like Chile and Brazil, those markets are really starting to price in a rate cut in the second half of next year,” Calic told Reuters .

Calich added that while the cycle is also coming to an end, central and eastern European central banks still need to make several more rate hikes.


Overall, many of the largest emerging market economies enjoy better fundamentals due to higher commodity prices, with Brazil, Mexico or Countries like South Africa are raising interest rates, building reserves and enjoying healthy trade balances.

Deeper liquidity in major emerging economies means they can focus on raising debt locally. For smaller, riskier emerging markets, however, there has been little slack.

In these so-called frontier markets that issue international bonds, a record 14 saw their bonds trade at a premium of more than 1 , 000 above the basis points of safe-haven U.S. Treasuries. Many other countries such as Egypt or Kenya are just one step away from these levels.

Such large bond yield spreads mean that these countries are effectively excluded from the market and cannot be refinanced at this stage. Many countries – such as Egypt and Ghana – have been knocking on the door of the International Monetary Fund (IMF) to help shore up their money.

Raphael Kassin, head of emerging markets hard currency debt at Itau Asset Management, said investors need to know how long rates will stay in place.

“If it’s temporary, that’s fine. Most countries don’t have big funding needs this year or next. What really matters is what happens in the long run.”



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