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Wednesday, August 16, 2006

The Fed Effect on Emerging Markets

By Yaser Anwar, CSC of Equity Investment Ideas

The Fed is caught between two opposing forces. The economy is slowing and the housing market has gone from a high rate of consumption, to slowing down at an alarming pace.

Conversely, core inflation will continue edging up in the near run, regardless of how the economy performs.

Emerging Market equities have rebounded about 15% in the past two months, following the deep correction in May. There could be more upside in the near term in response to the Fed’s rate pause last week, but history suggests EM stocks will likely struggle if the Fed tightening cycle is over.

EM stocks are growth sensitive and tend to advance when the Fed is hiking interest rates because the latter reflects improving U.S. economic conditions.

While the structural story for EM stocks remains positive, the developing slowdown in the U.S. is a powerful headwind, especially since Chinese policymakers are also trying to cool their commodity-intensive economy.

This has led me to a neutral stance on EM stocks in equity portfolios & long on the U.S. Treasurys, which are percieved as a safe-haven during an economic slowdown.

Sources: Bloomberg & Haver

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