Emerging economies gain breathing room as Fed pause expectations strengthen

Growing expectations that the US Federal Reserve will leave interest rates unchanged at its October meeting give emerging economies a brief window to reassess refinancing plans and manage external borrowing pressures. 

Market expectations for an immediate rate increase have weakened considerably. Recent pricing indicated only about a 20.5% probability of a Fed rate increase in October, down from roughly 51% a week earlier.

However, investors continued to assign an 84.5% probability to another increase in December, suggesting that markets were postponing rather than abandoning expectations of further tightening.

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The shift followed signs of moderation in the US labour market. Nonfarm payroll employment increased by only 29,000 in September, while the unemployment rate stood at 4.2%, according to the US Bureau of Labor Statistics.

Minutes of the Federal Reserve’s September meeting nevertheless indicated that inflation remained a major policy concern. Most participants considered another increase in the federal funds rate likely to be appropriate by the end of the year, while stressing that future decisions would depend on incoming economic data.

The Fed raised its target range by 25 basis points to 3.75-4% at that meeting, keeping borrowing conditions restrictive for economies dependent on international capital markets.

Ali Barkat, Group Taxation Manager at Gifto Industries, told Wealth Pakistan that an October pause could temporarily reduce the pace at which external financing conditions were tightening for emerging economies.

“For developing countries, even a pause matters because it reduces the immediate risk of another increase in the benchmark rate against which international borrowing is priced. It can give governments and companies a little more room to assess refinancing options, but it should not be interpreted as a return to cheap global liquidity,” he said.

Barkat said the distinction between a pause and the end of monetary tightening was particularly important for emerging-market borrowers.

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“A government planning to issue international debt cannot look only at the next Fed meeting. It has to consider where US rates and Treasury yields may be over the entire life of the borrowing. If markets expect another increase in December, lenders will continue to price that risk into financing,” he said.

That pressure remains visible in long-term US borrowing benchmarks. The 10-year Treasury yield stood at 5.28% on October 7, while the 30-year yield was around 5.67%, keeping the base cost of dollar borrowing elevated even as expectations for an October Fed move weakened.

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Emerging markets have already felt the effects of the latest tightening cycle. Foreign investors withdrew $26.3 billion from emerging-market stocks and bonds in September, the first monthly outflow since June.

Fixed-income markets alone recorded $7 billion in withdrawals, according to Institute of International Finance data reported this week.

The World Bank, however, notes that developing economies have proved surprisingly resilient during this surge in advanced-economy yields. Dollar-denominated sovereign spreads have narrowed in many markets, partly absorbing the increase in US Treasury rates.

This relative resilience has helped limit the rise in borrowing costs for some developing economies, although the benefits have not been evenly distributed.

Median borrowing yields for weaker-credit developing economies remain around 9%, compared with about 6.3% for stronger borrowers. Countries carrying larger amounts of short-term debt face yields of around 7%, leaving them particularly exposed when existing obligations have to be refinanced.

For countries with substantial external repayments, the prospect of a temporary pause in US monetary tightening provides an opportunity to review borrowing strategies, manage repayment schedules and explore alternative financing arrangements before global conditions change again.

Barkat said the present period should therefore be treated as an opportunity to reduce refinancing vulnerability rather than a signal to increase borrowing aggressively.

“For countries facing external repayments, a temporary easing in expectations can be useful for extending maturities, diversifying financing sources or arranging concessional funding. The risk would be to assume that the pressure has permanently disappeared,” he said.

With the Fed’s next policy meeting scheduled for October 27-28, incoming inflation and economic activity data will determine whether current expectations of a pause persist.

Barkat said emerging economies need to capitalize on any temporary improvement in financing conditions to strengthen their debt-management strategies, as elevated Treasury yields and potential monetary tightening continue to threaten future refinancing costs.

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