Emerging Markets Falter as Fed Dampens Rate Cut Hopes

Emerging market stocks and currencies started October on a downbeat note following comments from Federal Reserve Chair Jerome Powell. Powell's indications of only modest rate cuts prompted investors to reassess their expectations, stemming a recent rally in EM assets. Key manufacturing data underscores mixed performances across major emerging economies.

Emerging market stocks and currencies kicked off October on a somber note after Federal Reserve Chair Jerome Powell's recent statements scaled back expectations for substantial U.S. rate cuts, dampening an investor risk-on attitude that had bolstered the asset classes in the previous month.

Powell's comments, suggesting only quarter-percentage-point rate reductions and a cautious approach in light of promising economic data, led market participants, as shown by CME's FedWatch Tool, to reduce their bets on a significant 50-basis-point rate cut in November. DBS strategists emphasized the uncertainty of future cuts, citing forthcoming non-farm payrolls data and U.S. Presidential election sentiments.

Consequently, the dollar index strengthened against major currencies and the momentum in emerging market (EM) assets slowed with Chinese markets closed for public holidays. The MSCI index for EM stocks dipped by 0.1%, reversing gains seen in the previous month due to favorable economic reforms in China and the Fed's September rate cut.

The index for EM currencies also slipped 0.4%, following a notable three-month winning streak. Economic health indicators highlighted mixed manufacturing activity, with contraction observed in the Czech Republic, Hungary, and Turkey, while Poland showed signs of stabilization. Additionally, the Polish zloty strengthened marginally, while the South African rand and Czech crown weakened.

In other developments, Sri Lanka is poised for IMF discussions on a substantial bailout package, with its benchmark index seeing a rise and the rupee strengthening to its highest level since June 2023.

(With inputs from agencies.)