Can EM continue to shine?

Emerging markets have outperformed US assets this year, driven by a weaker dollar, attractive valuations, and strong earnings. EM equities have doubled US returns, while EM debt offers yields above 7.5%.

However, the Fed's latest rate hike could create headwinds by strengthening the dollar. This makes energy more expensive and increases borrowing costs for emerging economies. Despite this, many EM countries have strengthened their institutions and diversified economies, potentially mitigating the impact of past Fed tightening cycles.

The outlook for continued EM outperformance hinges on the duration of the Fed's rate-hiking cycle. A soft landing scenario, where inflation moderates and growth slows but remains positive, appears most favorable for EM assets, particularly emerging market equities and debt, provided the dollar stays range-bound. Persistent inflation and a firmer dollar would likely pressure EM debt. The resolution of the Iran conflict is a key wildcard; its end could slow inflation and shorten the Fed's hiking cycle.