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Should These 3 Emerging Country ETFs Fear Fed Rate Hikes?

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Hurt by the double whammy of a hawkish Fed and trade war fears between the United States and China, emerging market (EM) investing went into a tailspin lately. iShares MSCI Emerging Markets ETF (EEM - Free Report) lost 10.7% in the last three months against a 1.7% gain in the S&P 500 index.

Inside the EM Pain

The Fed is now planning a total of four rate hikes in 2018. This is against the Fed’s previous projections of total three rate increases for this year. An improving U.S. economy has given a boost to the greenback as evident from 5.8% three-month gains in Invesco DB US Dollar Bullish (UUP - Free Report) .

Meanwhile,the European Central Bank (ECB) has announced plans of exiting the QE policy by the end of this year. The withdrawal of support from the ECB and Fed may cause an upheaval in the EM space (read: Top and Flop EM ETFs as Taper Tantrum Completes 5 Years).

Added to this were trade war tensions. Both China and the United States are now eyeing a 25% tariff on each other’s $50 billion of goods. The situation may take an ugly turn as White House said this week that if China keeps retaliating to U.S. tariffs, the United States will enact tariffs on an extra $200 billion worth of Chinese goods (read: Fed, Trade & Global Politics to Rule June: 6 ETF Picks).

Funds Fleeing EMs

Foreign investors yanked about $5.5 billion from emerging market economies since the last Fed meeting, per the Institute of International Finance. While EM equities saw total outflows of about $4.2 billion since the Fed’s policy meeting, bonds saw an exodus of $1.3 billion (read: Inverse EM ETFs to Gain as Easy Money Starts Drying Up?).

Is the Pain Same for All EM Countries?

Pobably no. Per an article published on Reuters, economies with current account deficits should especially bear the burden of Fed rate hikes. These are economies like India, Indonesia, Philippines, Turkey and Argentina.

India's current account deficit (CAD) widened to 1.9% of GDP in the 2017-18 fiscal year, from 0.4% of GDP in the year-ago period. Indonesia’s CAD was around 2.15% of the GDP in the first quarter of 2018. Philippines, Turkey and Argentina recorded a CAD to GDP of 0.80%, 5.50% and 4.80%, respectively, in 2017.

These countries had to resort to a policy tightening lately to contain the decline in their respective currencies. But there are EM countries that are running surpluses and apparently less scathed by the Fed rate hikes.

Turn to EM Countries With Current Account Surplus

Current Account Surplus (CAS) indicates that there is a net inflow of foreign exchange in the economy, which in turn appreciates the currencies of those economies with surplus.

These countries are South Korea, Taiwan and Thailand.South Korea and Thailand’s Current Account surplus to the country's GDP were 5.60% and 10.60% in 2017, respectively. Taiwan’s Current Account surplus to GDP of 13.40% in 2016 was especially noteworthy.

The Reuters article explained that investors have a tendency to hold riskier longer-term debt in surplus countries as their bonds have lesser interest rate risks. Most economists now expect maximum one rate hike in Thailand, Taiwan and South Korea over the next one-and-a-half years, compared with the Fed’s five or six.

As a result, surplus countries are not struggling with the dollar’s surge that badly. Per Reuters, the Korean won, the Thai baht and the Taiwan dollar shed about 3% from the January levels close to multi-year highs while their central banks are comfortable in keeping the rates low. On the other hand, the Philippine peso (down 7%), the Indian rupee (down about 7%) and the Indonesian rupiah (down about 5%) fell considerably since January highs despite rate hikes.

YTD Price Performance

In the last six months (as of Jun 20, 2018), EEM has lost about 3.1%. iShares MSCI Philippines ETF (EPHE - Free Report) (down 19.2%), Global X MSCI Argentina ETF (ARGT - Free Report) (down 19.2%) and iShares MSCI Indonesia ETF (EIDO - Free Report) (down 9.8%) have lost heavily.

However, iShares MSCI Thailand Capped ETF (THD - Free Report) (down 4.3%),iShares MSCI Taiwan Capped ETF (EWT - Free Report) (up 2.7%), iShares MSCI South Korea Capped ETF (EWY - Free Report) (down 6.5%) are less beaten down.

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