Aug 01, 2015

Emerging Markets in a Rising Rate Environment

By Howie Schwab

Emerging Markets in a Rising Rate Environment

Lower borrowing rates traditionally have been positive for most emerging markets, including Southeast Asia. Despite the rapid decline of interbank rates in several of these markets, rates in some economies are now so low that the negative effect of margins is more than offsetting any benefit from loan growth.

In 2013, emerging markets were in the early stages of currency weakness and expectations were for localized rate hikes to protect the currency and capital. This is no longer the case as the charts below illustrate. To some degree, the ongoing weakness in domestic demand has mitigated the pass-through effect of FX on inflation in a number of developing nations. As such, rate hikes are not as essential as in past circumstances despite the ongoing weakness in EM currencies. This partly reflects the realities of a “QE world,” in which countries are comfortable devaluing their currencies for competitive purposes.

Exhibit 1: EM 5y Rates Weighted Yield* (Red) vs. 10y UST Yield

Sources: Citi Research and Bloomberg *Weighted average BRL, MXN, PLN, MYR, ZAR, TRY

Exhibit 2: EM 5y Rates (Red) vs. Weighted Index EM FX vs. USD*

Sources: Citi Research and Bloomberg *Weighted average BRL, MXN, PLN, MYR, ZAR, TRY, Higher=Strong USD

Historically, many EM banks have been asset sensitive with higher rates driving higher net interest margin (NIM) and ROE. Given the post-global financial crisis increase in credit leverage (and carry trades), there should be a greater divergence in performance in tandem with this round of rate hikes. Because most lending is priced off of the short-end of the curve, steeper yield curves alone are unlikely to boost NIMs. Instead, steeper yield curves should benefit banks that can redeploy excess liquidity into longer-dated securities for higher asset yields (e.g., insurance, etc.). Hence in this cycle, a steeper yield curve is likely to prove negative for the ASEAN region and countries like Turkey, whereas fee-based financial systems or current account surplus nations—like Taiwan or Hungary—stand to deliver relative outperformance.

This information is not intended to provide investment advice. Nothing herein should be construed as a solicitation, recommendation or an offer to buy, sell or hold any securities, market sectors, other investments or to adopt any investment strategy or strategies. You should assess your own investment needs based on your individual financial circumstances and investment objectives. This material is not intended to be relied upon as a forecast or research. The opinions expressed are those of Driehaus Capital Management LLC (“Driehaus”) as of August 2015 and are subject to change at any time due to changes in market or economic conditions. The information has not been updated since August 2015 and may not reflect recent market activity. The information and opinions contained in this material are derived from proprietary and non-proprietary sources deemed by Driehaus to be reliable and are not necessarily all inclusive. Driehaus does not guarantee the accuracy or completeness of this informa­tion. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the reader.

About Howie Schwab

Howie Schwab is the lead portfolio manager for the Emerging Markets Growth strategy and a portfolio manager for the Emerging Markets Small Cap Equity and Global strategies.

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