March 16, 2017 / 10:01 AM / 4 months ago

Dovish Fed boosts emerging assets, stocks at 20-month high

A police officer keeps watch in front of the U.S. Federal Reserve building in Washington, DC, U.S., October 12, 2016.Kevin Lamarque//Files

LONDON (Reuters) - A widely anticipated U.S. interest rate hike combined with a dovish outlook for the future path of rates lifted emerging stocks to 20-month highs on Thursday but also prompted a number of developing central banks to tighten monetary policy.

MSCI's emerging equity index jumped nearly 2 percent - the biggest daily gain since last July - after the U.S. Federal Reserve administered a widely expected 25 basis point interest rate hike but sounded a less hawkish tone than many had anticipated on the path of future rates.

Propelled by dollar weakness and rising commodity prices, emerging currencies also sailed higher. Taiwan's dollar touched a 10-month high, South Korea's won strengthened over 1 percent and commodity currencies such as the rand and rouble rose around 0.5 percent.

Average premia on emerging sovereign dollar bonds tightened six basis points to 309 bps.

"Emerging markets are in a sweet spot," said Inan Demir, senior emerging market economist at Nomura.

"This was the best scenario indeed, because the Fed is confident enough to hike, confident enough in the U.S. economic performance but it also doesn't sound in the mood to take away the punch bowl."

The normalisation of Fed monetary policy also pushed some emerging market central banks to follow suit: China's central bank increased short-term interest rates for the third time this year in a move seen aimed at curbing capital outflows and supporting the yuan.

Hong Kong, which pegs its currency to the U.S. dollar, raised benchmark interest rate by a quarter point

Four Gulf central banks – Saudi Arabia, the United Arab Emirates, Kuwait and Bahrain, also with currencies pegged or loosely tied to the dollar, also raised interest rates. Qatar and Oman are expected to follow.

Investors are awaiting the outcome of a central bank meeting in Turkey where a large external deficit makes it vulnerable to higher U.S. borrowing costs.

After jumping nearly 2 percent in the wake of the Fed meeting, the lira slipped 0.4 percent on Thursday. Analysts widely expect the central bank to stay put on benchmark rates but anticipate a possible hike in the late liquidity window, the facility though which it funds banks.

"A token rate hike in the late liquidity window is possible, maybe 25 bps or maybe 50 bps, but after having seen the lira performance last night the chances of no change have increased as well," said Nomura's Demir.

Indonesia's central bank, also scheduled to release its latest decision on Thursday, is expected to keep its benchmark interest rate unchanged in a bid to spur economic growth.

Reporting by Karin Strohecker; Editing by Toby Chopra

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