Emerging market assets are once again feeling the squeeze, caught in the crossfire of U.S. Federal Reserve missteps, Donald Trump’s unpredictable ambitions, and China’s underwhelming stimulus efforts. Recent price fluctuations in some of the most risk-sensitive economies raise concerns that the Fed’s decision to cut interest rates may have been premature and potentially disastrous.
On 18 September, the Fed launched its much-anticipated easing cycle, slashing rates by a hefty 50 basis points—twice the expected cut. Yet rather than delivering the anticipated relief, the move has confused emerging markets. These assets have traded as though U.S. borrowing costs will remain stubbornly high, with little optimism in sight. In just over a month, the Fed’s attempt at easing has been entirely overshadowed by new risks, further driving global investors away from this asset class.
Typically, when the Fed eases, emerging markets benefit from lower U.S. yields and a weaker dollar, but not this time. Instead, we’ve seen higher Treasury yields, a stronger dollar, and greater volatility in currency markets. The main culprits? Trump’s protectionist ambitions and China’s underwhelming response to its economic troubles.
Once again, emerging markets are forced into a defensive stance, stuck between an inflationary U.S. and a deflationary China. We’re still living in a world with two existential threats for emerging markets: the weakness in China and Trump’s unpredictability. A strong U.S. economy without inflation benefits emerging markets, but persistent inflation delays further Fed cuts and weighs on all risk assets.”
It’s becoming clear that the Fed, in its eagerness to undo past mistakes, may have acted too late by hiking rates for far too long and is now easing too early. The central bank’s clumsy timing has compounded the problems faced by emerging markets. The Fed’s attempt to throw these markets a lifeline was promptly yanked away by robust U.S. economic data, reigniting fears of persistent inflation. And as if that wasn’t enough, Trump’s rhetoric of tariffs and protectionism has worsened the outlook. Should Trump’s plans come to fruition, we could see U.S. consumer prices rise, undermining demand for exports from developing nations—already a fragile lifeline.
The unpredictability doesn’t stop with Trump. His protectionist stance is coupled with the possibility of a full-blown economic confrontation with China, just weeks away from the U.S. election.
Emerging market hedge funds have already taken defensive positions, increasing bets against vulnerable developing economies and favouring the safety of the U.S. dollar. Stocks in these markets briefly rebounded after the Fed’s September decision, but that momentum quickly fizzled. Local currencies and bonds are now on track for their worst month since February 2023, with segments of the dollar bond market, such as long-term and investment-grade debt, continuing to underperform.
The data backs up the gloomy outlook: Bloomberg shows that the average yield on dollar-denominated emerging market sovereign bonds has risen by 9 basis points since 18 September, with local currency bonds seeing the same increase. However, local currency bonds are struggling in dollar terms as weakening currencies pile on additional pressure.
Rising geopolitical tensions, China’s underwhelming efforts to stimulate domestic consumption, and the U.S. presidential election looming large are further complicating the landscape. These factors will likely push risk premiums even higher through the end of the year.
Emerging market bonds should, in theory, benefit from global monetary easing. However, the rebounding U.S. dollar and delays in monetary easing are triggering profit-taking, leaving investors in emerging markets waiting for clearer skies that may not arrive anytime soon.
In the end, the Fed’s blunder of raising rates too late and cutting them too soon has only added to the uncertainty for emerging markets, and with Trump and China in the mix, the future looks anything but stable.