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Fed Rate Hike: Opportunity or Risk for EM? · UBS Trending

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  The Federal
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  Reserve is
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  raising rates,
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  sending shockwaves through global markets
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  on the emerging markets side. Stocks and bonds.
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  Are they strong enough to withstand the pressure?
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  Well we're going to break down the opportunities and the risks
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  right here on UBS Trending.
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  Hi everyone and welcome to UBS Trending.
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  I'm Anthony Pastore
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  and I am back here with Alejo Czerwonko CIO for Emerging
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  Markets here at UBS.
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  Alejo thank you for coming by. So happy to be here.
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  You're here on an auspicious part of the week.
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  The Federal Reserve in the U.S.
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  just raised interest rates by 25 basis points.
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  Big deal.
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  It is a big deal.
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  Even though the market was pricing it in when it happened,
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  there was a strong market reaction
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  on the US side, especially with equities and bonds.
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  But of course, when you come back,
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  we want to talk about what's going on in the emerging world.
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  So with the Fed raising rates,
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  how does that impact emerging markets?
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  Because you would think just on paper, if rates are going
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  up, the dollar value could potentially go up,
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  which could maybe cause problems
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  for currencies in emerging countries.
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  So how are you thinking about the impact
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  that it could have there?
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  That's right Anthony.
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  Whatever the Fed does matters.
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  But the overall health of liquidity conditions
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  and the global economy matters even more.
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  If you think about it,
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  the Fed can influence global financial conditions,
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  but it's just one element in, you know, the universe of metrics
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  that we track.
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  Look at overall credit spreads near multi-decade low.
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  Look at equity markets globally near all time highs.
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  You mentioned the US dollar.
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  It has not moved even as the market priced
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  in an additional 100 basis points in hikes by the end
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  of the next 12 months.
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  So when you look at overall liquidity conditions
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  they're still pretty favorable.
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  In the words of Kevin Warsh, Fed chair just a few days ago,
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  he goes I would be hard pressed to conclude
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  that financial conditions are restrictive.
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  I agree financial conditions are favorable.
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  The global economy is going strong.
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  And therefore I think whatever we heard the Fed that recently
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  is one element emerging markets can continue
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  to perform in this environment.
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  Yeah.
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  And it's interesting because when we look at traditionally,
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  if you open up a textbook at this point in our history,
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  it would say something like dollar strengthens.
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  You know, emerging currencies will go down.
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  But that's not happening now as you said.
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  So interestingly then if you look at today's scenario,
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  let's break it down between emerging market equities
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  and emerging market debt.
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  So let's start with equities.
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  What happens on the equity side
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  when you look at stocks in the EM world.
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  What does that look like. Given what we know today.
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  We rate emerging market equities
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  as attractive in our global portfolio.
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  The reason being profit developments are solid
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  and valuations are not expensive.
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  Let me say a few more words on this to to clarify, earnings
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  this year for emerging market equities have been outstanding
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  60% earnings growth in 2026 and in 2027 we think
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  a continuation
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  of a fairly positive story with 20% earnings growth.
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  So you're getting this fundamental driver
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  coupled with valuations that are simply not expensive.
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  You can buy emerging market stocks at ten times earnings.
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  This is below ten year averages of 12.5 times earnings.
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  And this is a very sizable discount to the S&P 500.
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  No wonder Anthony when you look at performance year to date
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  emerging market stocks delivering twice the performance in U.S.
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  dollars relative to the S&P 500.
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  Take a look. At that chart that's up on the screen Alejo.
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  It was just there a second ago.
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  We'll bring it back up because I would love for you to talk to
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  what's there because it's broken down by country.
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  And it specifically talks about earnings growth and EM.
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  What are we looking at there.
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  I think this picture shows strength in earnings globally.
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  Right.
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  But a pretty standout performance in the emerging world in 2026.
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  That should extend into 2027.
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  So I think when you read this chart you conclude
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  equities should continue to go up supported
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  by earnings growth but not just in the United States,
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  in other geographies, specifically emerging markets as well.
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  Yeah. Now okay let's switch to the debt side.
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  The bond side.
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  How are do you how do you think EM
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  bonds are prepared to handle the cycle
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  that we're about to get into now?
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  I think performance so far this year speaks for itself.
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  Emerging market bonds are up in 2026.
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  And you have an attractive view on them.
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  Now we have an attractive view right.
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  Just think about it. We've got war in the Middle East.
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  We've got a Fed that is discounted to hike 100 125 basis points.
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  That's what's in the price today.
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  And as you can see in the chart, emerging market bonds delivering
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  positive total returns this year.
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  This speaks to the resilience of the asset class.
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  This is a reflection of a maturing asset class
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  because these countries are increasingly issuing debt
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  in their own currencies.
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  Instead of depending on the US
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  dollar, they're increasingly issuing
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  longer term instead of issuing shorter term.
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  Shockingly, in many emerging markets,
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  the average duration of government debt is larger.
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  Higher than that of the United States, right?
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  So this helps you mitigate shocks.
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  You don't have to be rolling over short term paper constantly,
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  which allows you to weather changes in liquidity conditions
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  a bit more aptly.
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  It's funny you mentioned textbooks.
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  I teach at Columbia.
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  I have a class on the history of capital markets
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  the last 40 or 50 years.
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  And spot on.
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  Whenever the Fed hikes, the dollar strengthens.
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  This has traditionally been an issue for emerging markets,
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  but this time it's not going to be dramatically different.
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  But things are evolving.
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  And you got to take into account
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  the specific circumstances that we're living through.
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  It is funny how it feels like over the last couple of years from,
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  you know, Covid through, you know, all of the economic cycles
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  that we've seen since then.
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  It does seem like the tagline for every episode
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  is this time it is different. Yeah.
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  And you know what? Dangerous words. But, you know.
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  Keep that up.
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  And sometimes it's not drastically different.
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  It's just slightly different. That's right.
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  But it is not really easy to just open a textbook and say,
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  oh, traditionally this is what happens when the Fed hikes.
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  It's a little bit different this time.
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  Like the world is changing so much.
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  That's what we're living through.
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  Revolutions, geopolitical revolutions, technological revolution.
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  And even from a financial markets perspective,
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  it's a different world.
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  Yeah. With, say, a U.S.
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  Treasury that is more active, intervening
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  in currencies, intervening in rates, markets.
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  This is relatively new.
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  I mean, we haven't seen this in our lifetimes.
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  Yeah.
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  So I guess the the
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  the big question is,
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  and obviously we don't have a crystal ball
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  sitting here on the table with us,
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  but what could go wrong that could upset
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  your views on stocks and debt as we look forward?
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  I mean, could we see, more of an escalation
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  on the Middle East conflict, other
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  geopolitical issues could arise.
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  There's an any number of things.
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  What do you think could go wrong that could upset this view?
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  That's exactly what we're looking at.
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  Number one, geopolitics.
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  If, say,
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  the situation in the Middle East
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  worsens dramatically,
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  impacting the flow of
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  commodities further,
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  that could be an issue for risk assets globally.
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  Emerging markets and other risk assets.
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  In addition, if the Fed were to hike
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  a lot more aggressively than than is currently priced,
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  then that is something else that you should take into account.
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  So we're looking at this, this
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  constellation of factors, but with the information we have today,
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  considering they,
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  state of global financial conditions, right?
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  Considering the health of the global economy,
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  there's growth in the US,
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  in Asia, in Latin American parts of Europe.
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  We think emerging markets can continue to deliver
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  solid performance unless something changes dramatically.
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  Right.
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  And hopefully it won't.
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  And like,
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  you know, you read that you spoke the quote that came from Warsh
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  about talking about he'd be hard pressed to conclude
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  financial conditions are restrictive.
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  You know, right there obviously the Fed is fighting inflation.
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  It's a little bit higher than where they want it to be.
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  It's above their 2%, you know mandate.
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  But you know
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  there's a lot also that's going into that inflation number.
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  Oil prices have gone higher because of the conflict.
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  So there's a lot of other factors under.
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  Direct control. Beyond their direct control. Exactly.
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  So it feels like hopefully we're on a path to keep things
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  where they are.
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  And so you can keep that attractive rating on EM bonds and on EM
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  stocks developing story.
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  That's right. Exactly as it always is Alejo.
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  Thank you. Always. Good to see you. Thank you. Thanks very much.
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  We appreciate your insights as always.
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  And if you want more information on everything
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  coming out of our Chief Investment
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  Office, including Alejo and his team,
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  make sure to visit our website at ubs.com/views.
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  Plus, you can follow us on social media.
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  We're on LinkedIn and Facebook.
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  Plus, the studio has its own dedicated channel @UBStrending
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  all the content from the studio
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  that you're not going to find anywhere else.
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  And as always, please, if you have any questions
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  or want to continue this conversation,
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  make sure you're doing so with your financial advisor.
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  Until next time, I'm Anthony Pastore.
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  Have a great rest of your day everyone,
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  and remember to keep your eyes on what's trending.
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  We'll see you soon.