Investors Bet on Emerging Markets as Fed Signals Easing and Fiscal Discipline Shine

Emerging markets are increasingly being positioned to outperform developed economies in the coming months, driven by a combination of looser U.S. monetary policy expectations, tighter fiscal management in emerging economies, and shifting investor allocations. Analysts from institutions like Fidelity International, T. Rowe Price, and Ninety One have highlighted these factors as key contributors to a potential outperformance by emerging market (EM) equities and assets over their developed counterparts.

The shift in sentiment has been reflected in capital flows. The iShares Core MSCI Emerging Markets ETF has attracted over $5.8 billion since April 2, representing roughly 5.8% of its total assets, while the Vanguard FTSE Developed Market ETF saw inflows of $5.6 billion over the same period. These figures underscore a growing investor appetite for emerging market exposure amid expectations of a Fed rate-cutting cycle beginning in September.

Federal Reserve Chair Jerome Powell’s recent remarks at the Jackson Hole symposium added momentum to these expectations. Powell indicated that the Fed is likely to ease monetary policy to counterbalance growing risks in the labor market, which he described as being in a “curious balance” of both slowing supply and demand dynamics. This dovish stance has been interpreted by market participants as a signal for accommodative monetary policy, which is expected to benefit emerging markets by reducing the U.S. dollar’s strength and lowering global borrowing costs.

Emerging markets also appear to have structural advantages. Analysts point to disciplined fiscal policies, lower inflation surprises, and a more favorable valuation environment as additional tailwinds. The Citi Inflation Surprise Index for emerging markets has averaged -19 this year, compared to -12 for developed economies, suggesting that inflationary pressures are more contained in the former group. This creates room for monetary easing and supports growth without triggering runaway inflation.

Fund managers emphasize that EM governments have generally maintained tighter fiscal control, avoiding the unsustainable deficits seen in some developed economies. “We don’t see these huge unsustainable fiscal deficits that you see in developed markets,” said Archie Hart of Ninety One, highlighting the role of fiscal prudence in supporting economic resilience.

Currency dynamics further support the case for emerging markets. While the U.S. dollar remains strong, analysts like Thomas Poullaouec from T. Rowe Price point to Latin American currencies, particularly the Brazilian real, as areas of opportunity. These currencies offer elevated carry and improving fiscal sentiment, though Poullaouec also cautions that much of the upside has already been priced in.

Looking ahead, the MSCI Emerging Markets Index is forecasted to rise by approximately 15% over the next year, compared to around 10% for developed markets. These forecasts, however, remain contingent on economic and political developments, particularly in key emerging economies like India, Brazil, and China. The potential for rapid and uneven growth across the EM landscape introduces inherent volatility and requires a selective investment approach.

The broader macroeconomic environment continues to evolve. While the Trump administration's tariff policies have introduced uncertainty, analysts suggest their inflationary impact is expected to be short-lived. This dynamic, coupled with the potential for Fed easing, is seen as a catalyst for continued investor rotation into EM assets.

Source: [1] Emerging Market Economies: Definition, Growth, and Key (https://www.investopedia.com/terms/e/emergingmarketeconomy.asp) [2] Why emerging markets will beat developed economies in 2025 (https://www.cryptopolitan.com/why-emerging-markets-will-beat-developed-economies-in-2025/) [3] Powell says Fed may need to cut rates, will proceed carefully (https://www.reuters.com/markets/wealth/powell-says-fed-may-need-cut-rates-will-proceed-carefully-2025-08-22/) [4] Powell suggests rate cuts are coming — but not because (https://www.cnn.com/business/live-news/fed-powell-jackson-hole)