For emerging markets, the tide seems to be turning on hopes of a rate cut

On Wednesday, the US Fed held the Federal Funds rate steady at 5.25%-5.5%, as expected. Fed chair Jerome Powell’s commentary indicated that the recent high US inflation number and a strong labour market wouldn’t push the central bank to delay rate cuts, bolstering investor sentiment for Asian equities on Thursday.

Interest rate cuts by the Fed tend to make the US dollar weaker, enhancing the appeal of EM equities. An easing monetary policy cycle means lower cost of capital and thereby willingness to take more risk. Collectively, these factors should ideally translate into higher fund flows into EM equities. After all, EMs have borne the brunt of global monetary tightening as elevated inflation and muted growth kept foreign investors jittery about the asset class.

However, recession worries are now subsiding and there are growing expectations of a soft landing for the global economy. If this scenario pans out, it should help export-focused EMs, often perceived as riskier than their developed counterparts.

Investors seem to have already switched to the risk-on mode. “The allocation to EM equities jumped 24 percentage points month-on-month to net 16% overweight, in the biggest monthly jump since April 2017, to the highest allocation since August 2023," said the latest BofA Securities global fund managers’ survey.

Another indicator of the sentiment turning in favour of EMs is the Bloomberg Emerging Markets Capital Flow Proxy Index, which at 153 points is ahead of its 10-year average of 143. And though the actual rate cuts are still a while away, stable global oil prices should in the interim support the macroeconomic outlook for net oil importers like India.

But foreign investors are likely to be selective on EMs and investment decisions would also depend on fundamentals such as earnings growth. An analysis of the Asia ex-Japan pack by Nomura Group showed that the December quarter (Q423) earnings season has disappointed market expectations yet again with more misses than beats leading to consensus downgrades for 2024 earnings estimates.

India, Indonesia and the Philippines have done better compared to North Asian companies, it said in a report dated 14 March.

Meanwhile, so far in calendar year 2024, the MSCI India index is up nearly 3%, beating the MSCI Asia Ex-Japan index and the MSCI Emerging Market index, which are flat. However, India's valuation multiple of nearly 20 times one-year forward price-to-earnings stands at a steep premium to its Asian peers, a sore point for investors.