Emerging Markets Posied for Brighter Outlook in 2024 with Dipping Oil Costs and Fed's Pivot

Emerging-market assets, including bonds and currencies, are set to be further powered in the year 2024, buoyed by the Federal Reserve's anticipated shift towards interest rate cuts and a significant drop in oil prices.

Prices have since dropped from the year's highs on Sept. 27, with U.S. benchmark West Texas Intermediate crude futures down 27% from $93.68 a barrel on the New York Mercantile Exchange, and global benchmark Brent crude down 24% from $96.55 on ICE Futures Europe.

This declining trend in crude is poised to decelerate inflation in developing nations, potentially spurring further interest in their bond markets. Additionally, currencies of emerging economies are expected to strengthen, especially benefiting those that are net importers of oil.

Manpreet Gill, Chief Investment Officer for Africa, Middle East, and Europe at Standard Chartered in Dubai, underscores the critical role of oil prices in influencing inflation or disinflation in emerging markets. He notes that in periods of disinflation, local-currency bonds become particularly attractive due to their direct exposure to local interest rates and currencies.

Net oil importers in Asia, including countries like India, the Philippines, Korea, and Thailand, are identified as primary beneficiaries of the lower crude prices. Vishnu Varathan, Asia Head of Economics and Strategy at Mizuho Bank Ltd. in Singapore, believes these nations may significantly benefit from the oil price pullback, with potential gains extending to the downstream petrochemical sector due to reduced crude input costs.

Bank of America analysts point out the altered relationship between commodity prices and emerging market currencies since the U.S. became a net oil exporter post-Covid. Higher commodity prices are now associated with weaker EM currencies and a stronger dollar, a reversal from the trend observed between 2010 and 2019.

The bulk of the recent uplift in emerging-nation assets is attributed to the growing consensus that the Fed may have concluded its rate-hiking cycle. The central bank's meeting in December saw traders pricing in up to six quarter-point cuts for the next year, leading to a decline in the dollar and a rally in risk assets.

CFRA's head of ETF Research, Aniket Ullal, remarks on the advantages for emerging markets heavily reliant on commodity imports in the context of a weakening dollar. Most commodities being dollar-denominated, a softer dollar translates into lower energy input costs.

Additionally, in a weaker dollar environment, capital flow towards emerging markets is expected to improve, reducing financial stress risks. Given that these markets typically issue debt in dollars, a depreciating dollar relative to their home currencies eases the repayment of dollar-denominated debts.

In essence, the convergence of falling oil prices and a potential Federal Reserve policy shift is setting the stage for a robust performance from emerging markets in 2024, particularly for those economies with heavy reliance on commodity imports.