Sell? Buy? Buy Then Sell? Fed’s Many Outcomes Stalk EM Investors

(Bloomberg) -- After months of feverish economic analysis and nuanced scrutiny of every Federal Reserve utterance, the U.S. is finally on the brink of its first rate cut since the financial crisis. Emerging-market investors are bracing for the impact.

While the market has fully priced in a quarter-point reduction, analyst estimates range from a 50-basis-point cut to no change. Policy makers announce their decision at 2 p.m. Wednesday.

Many investors are optimistic lower borrowing costs will boost appetite for riskier assets, while others are concerned the Fed won't meet the market's very dovish expectations. Even if developing-nation assets initially rally, some analysts say this may not last long as the weak economic growth that is underlying the monetary easing come to the forefront.

MSCI Inc.'s gauge for developing-nation equities declined 0.6% as of 9:02 a.m. London time, while the currency index was little changed.

Here are three ways leading investors are looking to play the various outcomes of tomorrow's meeting.

Disappointment

Chris Diaz, a money manager at Janus Capital Management LLC in Denver, is “significantly underweight” in emerging-market assets ahead of the Fed decision. He expects the central bank to cut rates by 25 basis points and says markets are pricing more easing than warranted.

“I struggle to see how the Fed can meet or exceed the market's dovish expectations,” Diaz said. “I would expect risk assets, including EM, to underperform risk-free assets.”

Diaz is also concerned about the global economy, which looks “pretty weak” outside the U.S. consumer space. He says weakness appears to be concentrated in trade and manufacturing, which is not good for developing nations. A dovish surprise could briefly provide some relief to those assets, but he says only a better growth outlook would make him more optimistic on emerging markets again.

Up Then Down

Many investors forecast a brief rally after a rate cut, before attention inevitably turns to sputtering global growth. Goldman Sachs Group Inc. is avoiding “naked long” positions in emerging markets as growth will probably keep slowing and says monetary easing won't be enough to reverse that trend.

Peter Cecchini, the global chief market strategist at Cantor Fitzgerald in New York, says the recent recovery in many emerging-market assets has been a function of the Fed's pivot earlier this year, and when markets realize growth will remain depressed, riskier assets will suffer.

“By the end of 2019, we feel that the global growth slowdown will be too much for EM assets even with easier policy,” Cecchini said. “The timing is tough, but sometime later in the year, EM risk assets will begin to underperfom.”

Embrace the Risk

Bank of America Merrill Lynch is bullish on developing nations, saying there is still room for gains, especially if the Fed cuts 50 basis points. The bank is long in emerging markets across asset classes, including debt in Argentina and Ukraine and equities in Brazil and China.

“We stay bullish on risk,” strategist David Hauner wrote in a report Monday. “If the data start to improve after September, an asset price boom may be upon us.”

Goldman Shuns ‘Naked Long' Bet in EM as Growth Seen Sputtering

Other investors are more selective. Morgan Harting, a money manager at AllianceBernstein in New York, is playing the risk via stocks. He has taken profit on some EM bonds that have rallied and bought equities instead, given the lower valuations and the faster growth in emerging markets compared with developed nations.

“Lower rates in the U.S. would benefit EM equities in two ways: first, it would lower the cost and availability of financing for companies, and second, it would mean investors discount future earnings at lower rates,” Harting said.

He sees good returns in China, India, Russia, Taiwan, Korea and Brazil.

To contact the reporter on this story: Aline Oyamada in Sao Paulo at aoyamada3@bloomberg.net

To contact the editors responsible for this story: Julia Leite at jleite3@bloomberg.net, Philip Sanders, Justin Carrigan

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