Emerging Markets Brace for Volatility as Global Tensions Escalate

The global financial landscape is in a state of flux as emerging-market currencies grapple with the fallout from the ongoing conflict in the Middle East and the shifting monetary policy landscape in the United States. As investors seek safe havens, the US dollar has gained strength, putting pressure on developing economies' currencies. Meanwhile, economic data from the US has fueled speculation about the Federal Reserve's future rate-cutting decisions, adding to the uncertainty.

Navigating the Turbulent Tides of Emerging Markets

Currencies Succumb to Geopolitical Tensions

Emerging-market currencies have taken a beating in recent days, with MSCI's benchmark for the asset class slipping for a third consecutive session. The decline, which reached as much as 0.5%, was driven by the surge in demand for the safe-haven US dollar as the conflict in the Middle East intensified. Investors are increasingly concerned about the potential for the conflict to escalate and disrupt energy shipments, which could have far-reaching consequences for the global economy.The impact of the geopolitical tensions has been particularly pronounced in Chile, where the peso sank the most during the US trading session. As a fuel importer, the country is expected to be hit harder by the prospect of higher oil prices. The broader gauge for developing nation equities also fell, with stocks traded in Hong Kong pulling back from a recent rally.

The Fed's Influence on Emerging Markets

The US economic data has also played a significant role in shaping the outlook for emerging markets. The latest figures showed that US service providers expanded in September at the fastest pace since February 2023, while applications for US unemployment benefits rose slightly last week. This data has bolstered the view that the Federal Reserve may not need to cut rates as aggressively as previously anticipated, potentially delaying the easing of monetary policy by central banks in emerging markets."Fewer cuts by the Fed may delay the easing by EM central banks, yet EM currencies still have a good cushion in terms of higher interest rates and have clearly benefited from the removal of the downside risk in China's economy," said Anders Faergemann, a fixed income portfolio manager at PineBridge Investments.Investors are now eagerly awaiting the release of the monthly US labor data on Friday, which could provide further insights into the Fed's policy path. "If the data comes rather strong, we going to see US rates going up again tomorrow and EM FX suffer a bit," said Marco Oviedo, a strategist at XP Investimentos.

Diverging Fortunes in Emerging Markets

Despite the overall risk-off sentiment, some emerging-market currencies have managed to buck the trend. Mexico's peso, for instance, shook off early losses to post slight gains, trading close to its 50-day moving average, a level it has struggled to break past since the country's elections in June.The resilience of the peso has been attributed to the inauguration of President Claudia Sheinbaum, who is expected to embrace more market-friendly policies than her predecessor. Investors are hopeful that Sheinbaum's leadership will provide a boost to the Mexican currency.Similarly, the Turkish lira strengthened marginally, despite the country's inflation accelerating faster than expected. The worse-than-expected inflation readings may delay what would have been Turkey's first rate cut since early 2023, potentially providing some support for the lira.

China's Stimulus Measures Buoy Investor Sentiment

While the broader emerging-market landscape has been dominated by uncertainty, the outlook for China has transformed in recent weeks. The country's recent barrage of stimulus measures has caught the attention of global investors, with HSBC strategist Alastair Pinder upgrading Chinese stocks to overweight and Morgan Stanley's Laura Wang suggesting that the country's equities can gain a further 10% to 15% as the government may announce additional fiscal measures to expand the existing stimulus."The rally has further to run," said Fredrik Bjelland, portfolio manager of the $1.5 billion Skagen Kon-Tiki emerging-market fund. "Chinese valuations are attractive. Moreover, flows have been negative for a number of years, leaving global investors' positioning light compared with history."The Hang Seng China Enterprises Index, the main barometer of sentiment on China this week as mainland markets remain closed, fell for the first time in 14 days, with losses at Alibaba Group Holding Ltd. and JD.com Inc. weighing on the gauge. However, the overall sentiment remains positive, as investors anticipate further policy support from the Chinese government to bolster the country's economic growth.