Emerging Markets Poised to Shine as Fed Signals Rate Cuts and Dollar Weakens

Jitania Kandhari from Morgan Stanley Investment Management recently highlighted a shift in economic conditions that may favor assets outside the United States. She pointed out that as the Federal Reserve adopts a more dovish stance with potential interest rate cuts, coupled with a weakening dollar, opportunities are emerging for emerging market equities to outperform their U.S. counterparts.

Serving as the Deputy CIO of Emerging Markets and Head of Macroeconomic Research, Kandhari noted that the factors which previously bolstered the dollar, such as robust economic growth and high interest rates, are now peaking. This transition creates a more advantageous scenario for international markets, with emerging markets exhibiting solid macroeconomic fundamentals.

Despite the occasional underperformance, Kandhari remains optimistic about the potential of emerging markets, dubbing this decade as "the decade for emerging markets." Although the MSCI Emerging Markets Index has risen 11% year-to-date by September 23, it still trails the S&P 500's 20% gain. However, she sustains a constructive outlook, with her firm managing $1.5 trillion in assets, asserting that emerging markets are the asset class of the decade.

Kandhari further explained that the prolonged period where the interest rate differential favored the U.S. due to tighter Fed policies and Washington's fiscal stimulus is coming to an end. The 4% yield on the 10-year U.S. Treasury is perceived as a conducive environment for emerging market assets.

As the Federal Reserve shifts towards lowering rates, emerging market central banks, which have so far been in a wait-and-see mode, may find fewer constraints in easing their own interest rates.

The Passport Overseas Equity Portfolio managed by Kandhari has outperformed its benchmark as of September 23, though U.S. markets have still excelled, driven in part by the strong performance of the technology sector.