Positive structural case for EM won’t collapse under a few Fed hikes

• BFA Global Research remains structurally bullish on emerging markets (EM) despite tactical caution driven by the Iran conflict and anticipated US Federal Reserve rate hikes.
• EM performance has exceeded the S&P 500 by more than doubling returns year-to-date, underscoring resilience during global volatility.
• Strategic outlook projects a buying opportunity in EM should weakness emerge from Fed hikes, with expectations for global inflation to decline and a weaker dollar to return in 2027.
• Fed policy forecast calls for three rate hikes by the end of 2026, taking rates back to early 2025 levels, a move considered a headwind for EM due to potential dollar strength.
• Tactical caution is currently advised until the Fed hike trajectory becomes clear in autumn, as investors remain underpriced on the likelihood of three hikes.
• US economic exceptionalism is identified as a risk factor, with strong US growth contrasting against weak demand in China and supply chain disruptions affecting Europe and Asia.
• Chinese market dynamics present an asymmetric picture: tech and exports are strong, but domestic demand remains weak and the RMB is undervalued by 10–15% based on fundamental models.
• RMB outlook faces pressure from potential Fed hikes, as low Chinese interest rates combined with higher foreign yields may encourage exporters to keep cash offshore.
• Flow analysis indicates that despite headwinds, investors continue to buy EM dips; however, global allocators remain structurally underweight EM compared to a decade of prior underinvestment.
• AI impact is viewed as constructive for EM only if productivity gains are global; a US-centric AI boom could strengthen the dollar and harm EM assets.
• Macro risks that could alter the bullish thesis include a larger-than-expected Fed hiking cycle, or escalating trade tensions between China and Europe.
• Currency strategy favors high-carry positions in Latin American and frontier markets (e.g., Turkey, Brazil, Argentina, Nigeria) over lower-yielding Asian currencies, with a specific long bias on the Chinese Renminbi due to its cheap valuation.

Brazil Equity Strategy (David Becker)

• Brazilian equity has underperformed the MSCI EM index over the last few months, trading more than 10% below year-to-date highs.
• Macro headwinds include a decline in oil prices (reducing gains for the oil-exporting economy) and a stronger-than-expected US dollar.
• Domestic outlook has been revised down: GDP growth forecasts for next year were cut from 2.0% to 1.3%, while inflation expectations have remained sticky.
• Monetary policy expectations have shifted from major rate cuts to a more cautious stance, as economic support measures have lowered unemployment but kept inflation elevated.
• Earnings risk is elevated for next year as market expectations rely heavily on lower interest rates, which may not materialize.
• October election presents a tight contest between incumbent President Lula and challenger Flavio Bolsonaro, currently showing polls within the margin of error.
• Fiscal uncertainty remains the primary market driver, as investors debate which candidate will pursue more significant fiscal adjustments to enable future rate cuts.
• Market positioning is characterized by caution, with few institutional clients willing to take structural positions ahead of the election due to potential volatility.

Forward-Looking Statements & Conditions

• Structural bullishness on EM persists unless the Fed hiking cycle exceeds three hikes or trade tensions significantly disrupt global growth.
• 2027 expectations rely on base effects from 2026 oil prices to lower global inflation, allowing for a return to lower rates and a weaker dollar.
• US Midterms could indirectly impact EM if they trigger a sharp pullback in US tech stocks, potentially weakening the dollar and reducing the urgency for Fed hikes.