EMs slump amid rising Middle East tension, Fed decision

by Zijia Song and Srinivasan Sivabalan 

Currencies and stocks in developing nations fell as escalating tensions in the Middle East and the upcoming Federal Reserve interest rate decision dimmed risk appetite.  

Indexes tracking emerging-market currencies and stocks saw losses of more than 0.4% each on Tuesday as Tehran was hit by a fresh wave of missiles. President Donald Trump was set to meet his national security team to discuss the conflict, fueling speculation that the US could join Israel’s attack on Iran.  

Both gauges pared losses on end-of-day adjustments, closing 0.1% lower each. South Africa’s rand, Hungary’s forint and South Korea’s won were among the worst performers among peers, down more than 1% versus the dollar. Israel’s shekel fell as much as 0.8% before trimming losses.  

Broad risk-off sentiment weighed on emerging currencies as tensions increased in the Middle East and as traders await the Fed decision tomorrow, according to Antje Praefcke, senior FX analyst at Commerzbank.  

The market also struggled to get clear signals from the latest US data, Praefcke added. While retail sales in May dropped for a second month, the so-called control-group sales — which feed into the government’s calculation of goods spending for gross domestic product — increased 0.4%. The dollar extended gains to 0.5%. 

“We expect a hold tomorrow but also for the FOMC to start laying the groundwork for a pivot to cuts in September, more of a ‘dovish hold’ kind of meeting,” Brendan McKenna, an economist at Wells Fargo in New York, said of the upcoming Fed meeting.  

In Latin America, Colombia’s peso outperformed while currencies in Chile and Mexico fell. Chilean officials are expected to hold the key interest rate steady later Tuesday, while signaling plans to resume monetary easing as global headwinds crimp growth and local inflation slows toward target. 

Credit markets 

Romania dollar bonds gained, outperforming most EM peers as President Nicusor Dan plans to hold formal talks with political parties on designating a new prime minister. The Bahamas is tapping global markets for the first time in three years, launching the sale of $1.1 billion bonds due in 2036. 

Despite Tuesday’s pressure, money managers say emerging-market gains and outperformance over US assets this year will continue as risks arising from the conflict will be neither deep nor lingering. Across bonds, currencies and stocks, measures of risk are contracting despite Israel’s war with Iran, as expectations of monetary easing, dollar weakness and an artificial intelligence boom dominate price action.  

“This year and next year, emerging markets will continue to outperform in terms of macroeconomic growth,” said Karnail Sangha, senior portfolio manager on the EM equity team at Robeco, who added that earnings for developing markets are much higher than what is expected for developed markets. “There’s also the realization that international investors have to allocate money elsewhere.”