Emerging-Market Rally Fades as Dudley Comments Spur Fed Concern

  • Developing-nation stocks little changed after eight-day rally
  • Futures trading shows increased odds of Fed increase this year

A rally in emerging-market assets lost its momentum after a Federal Reserve official said investors are underestimating the likelihood of a U.S. interest rate increase this year.

The MSCI Emerging Markets Index halted an eight-day advance after New York Fed President William Dudley said policy makers could raise borrowing costs as soon as next month. A gauge of developing-nation exchange rates pared its gain as futures trading showed increased odds for a U.S. interest-rate move. Turkish, Mexican and Hungarian stock benchmarks fell at least 0.7 percent. The South African rand weakened.

Investors have poured almost $17 billion in the past 11 weeks into U.S. exchange-traded funds buying stocks and bonds in emerging markets as investors bought riskier assets amid confidence the Fed will delay a rate increase until at least March next year. While traders now see about a 51 percent chance of a rate move by year-end, the odds of it happening next month are only 22 percent, according to fed funds futures. Dudley said such estimates are too low and that “the market is complacent” about the need for hikes.

“It is a nice reminder the emerging-market rally has been overstretched,” said Guillaume Tresca, a senior strategist at Credit Agricole CIB in Paris. “I expect sentiment to deteriorate gradually.”

Some indicators also suggest that the rally may have gone too far:

* Emerging-market stocks are trading at the highest price-to-earnings ratio since May 2015
* The 14-day relative strength index, a measure of how quickly an asset is rising or falling, has jumped to 77 for the developing-nation equity benchmark, near the highest level since April 2015

The MSCI Emerging Markets Index fell less than 0.1 percent 915.60, after rising as much as 0.4 percent. Six of 10 industry groups retreated, led by consumer-discretionary stocks.

Argentina’s equity benchmark rose the most in two weeks as the markets reopened after a holiday. Qatar stocks climbed after FTSE Russell said it would relax the criteria for which of the nation’s shares will join its emerging-markets index next month.

Dudley, who serves as vice chairman of the rate-setting Federal Open Market Committee, said Tuesday that the U.S. economy is getting closer to a point where an interest-rate increase would be appropriate. Asked whether policy makers could vote to raise the benchmark rate at their next meeting Sept. 20-21, Dudley said on Fox Business Network, “I think it’s possible.”

Bonds & Currencies

The MSCI Emerging Markets Currency Index added 0.2 percent, trimming an increase of 0.5 percent. Developing market currencies were buoyed by Brent crude’s four-day rally, even as traders placed further bets on a Fed rate hike by the end of the year.

South Korea’s won rose 1 percent after lackluster data from the world’s biggest economies fueled speculation central banks would continue with loose monetary policy. The Hungarian Forint and the Polish Zloty each rose more than 0.5 percent. The real fell more than 0.5 percent after President Dudley’s comments offset speculation that Brazil’s government will soon boost growth forecasts. The Russian ruble rose 0.4 percent.

Ten-year Polish government bonds fell after the Development Ministry cut the country’s growth outlook. The risk premium on developing-market sovereign bonds dropped four basis points to 332, according to JP Morgan Chase & Co. indexes.

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