As US Federal Reserve tapers, don't count out emerging market currencies

RupeeMarket participants will likely return to the emerging market world by buying the more solid fundamental names with attractive valuations and higher interest rates.

When the US Federal Reserve first started talking about cutting its massive stimulus earlier this year, emerging-market currencies went into a tailspin. This time round, investors don't see that happening.

Throughout the summer, while U.S. equities held relatively steady, riskier foreign markets were crushed, and their currencies battered by talk of a Fed pullback.

Now, many investors are convinced the Fed's tapering won't cause that kind of market volatility again, and U.S. rates won't spike, just rise slowly. If that's the case, investors will be emboldened to move back into emerging currencies.

The Fed cuts started this week when it reduced its monthly bond-buying to $75 billion from $85 billion. A reduction in the Fed's quantitative easing is supposed to benefit the greenback because it would raise U.S. rates, making those assets more attractive. It also curbs the supply of cash that tends to flow into riskier assets such as emerging market economies.

Some emerging market debt and currencies have become more attractive over the last six months, fund managers said, and the Fed's decision has not diminished their allure.

"Once the cat (Fed tapering) is out of the bag and the outcome should be much lower volatility than what we saw in the past, market participants will likely return to the emerging market world by buying the more solid fundamental names with attractive valuations and higher interest rates," said Thomas Kressin, senior vice president and head of European foreign exchange at global bond fund PIMCO in Munich, Germany.

Traders don't expect the Fed to hike interest rates earlier than July 2015.

When the Fed previously suggested it might start winding down its stimulus, some emerging market debt and currencies tumbled. The Indian rupee, for instance, has lost 11 percent this year.

"There has been significant underperformance in emerging market debt, not only in May and June, but also recently when rates have risen as well," said Mike Swell, co-head of global lead portfolio management, at Goldman Sachs Asset Management in New York, which manages more than $349 billion in fixed income, currency and commodity assets. cut?

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