Is Fed tightening a game changer for EM assets? UBS weighs in

Emerging market assets can withstand a more aggressive U.S. Federal Reserve, according to UBS analysts in a research note. The Federal Reserve raised interest rates by 25 basis points in September 2023, its first increase since 2023, and indicated that rates could stay above 4% through 2027. Markets had already priced in about three additional rate hikes by mid-2027, prompting the central bank to show a more hawkish stance. UBS forecasts only one more 25-basis-point hike.

While a more aggressive Fed typically harms emerging market assets, UBS believes they are better equipped to handle tighter U.S. monetary policy compared to previous hikes. The bank cited stronger external balances, improving sovereign credit quality, and greater policy independence for emerging-market central banks. Additionally, the U.S. dollar's role as a shock amplifier for emerging markets has weakened, with fiscal concerns reducing traditional safe-haven demand and the positive impact of higher energy prices and tighter Fed policy.

UBS strategists said equities would benefit from resilient earnings, relatively low valuations, and ongoing investment in artificial intelligence to offset potential volatility caused by Fed-induced turbulence. The bank anticipates EM earnings per share to grow more than 60% in 2026 and nearly 20% in 2027, while the MSCI Emerging Markets index trades at around 10 times forward earnings.

UBS also noted that Fed tightening is "not an insurmountable obstacle" to positive returns from high-yielding EM currencies, though narrowing yield differentials make diversification increasingly essential. Nonetheless, the bank highlighted rapid U.S. Treasury yield increases, weaker global growth, and geopolitical escalation as significant risks to the outlook.