Hawkish Fed triggers emerging market outflows in September

• Emerging market fixed income saw $7 billion in outflows, the first net outflows since March, with hard currency bond funds reversing to outflows following the FOMC decision
• South Korean stocks experienced heavy foreign selling, contributing to a $19.2 billion outflow from emerging market equities
• The hawkish Fed projecting further rate hikes, combined with Bank of Japan policy at its highest since 1995 and broad tightening across advanced economies, raises challenges for EM carry trades in Q4

Summary: Hawkish Fed Triggers Emerging Market Outflows in September

Foreign investors withdrew $26.3 billion from emerging market (EM) stocks and bonds in September, marking the first monthly outflow since June, according to the Institute of International Finance (IIF). The exodus was triggered by the Federal Reserve's hawkish monetary policy shift under President Kevin Warsh.

Key Outflows:

• $7 billion pulled from EM fixed income—the first net outflows since March
• $19.2 billion withdrawn from EM equities, driven primarily by heavy foreign selling of South Korean stocks

Market Drivers:

The Fed raised interest rates for the first time since 2023 and signaled ongoing inflation concerns, sending US Treasury yields sharply higher and strengthening the dollar. These moves prompted investors to retreat from riskier emerging market assets.

Timing and Impact:

Pressure intensified during the second half of September, particularly following the Federal Open Market Committee (FOMC) decision. Hard currency bond funds experienced outflows, while EM dollar credit spreads widened during the week of the Fed meeting.

Forward Outlook:

The IIF report warns that prospects for EM carry trades in Q4 face significant headwinds, including:

• A hawkish Fed projecting further rate hikes
• Bank of Japan maintaining its highest policy rate since 1995
• Broad monetary tightening across advanced economies

The combination of higher yields in developed markets and a stronger dollar has raised the bar for emerging market investments, potentially sustaining capital outflows as investors favor safer, higher-yielding assets in advanced economies.