The Dollar Rallies, and Emerging Markets Shudder
The Turkish lira has fallen 5.3% over the past month to an all-time low against the dollar, a factor in an unexpected downgrade Tuesday from Standard & Poor’s Global Ratings. Argentina’s peso has also fallen 5% over that period, even as the central bank has lifted interest rates and intervened in the foreign-exchange market to stem the decline. The MSCI Emerging Markets Index, which measures stock performance, is down 1.5%, while a JPMorgan index that tracks emerging-market government bonds issued in local currencies has fallen 3.6% over the past month through Tuesday.
The declines illustrate the increasingly uncertain outlook for emerging-market assets. Those markets surged in 2017 and held up throughout the volatility of February and March, as investors remained confident in global growth and the benefits of a weak U.S. dollar. Investors are now facing new risks, from rising expectations for U.S. interest-rate increases to questions over the path for global growth.
The selling threatens to inject fresh volatility into global markets, which have been rocky in recent months as investors parsed rising trade tensions, the climb in global interest rates and questions over regulation of the technology sector. Emerging-market assets are often seen as a barometer of risk appetite and big declines in those markets can sway broader sentiment and expectations for global growth.
“There was a lot of confidence, verging on complacency, going into the year,” said Sonja Gibbs, senior director of global capital markets at the Institute of International Finance. “If you have investors getting spooked and pulling money out abruptly, that can have ripple effects.”
Analysts stress that the dollar’s rally could quickly reverse. And while the The Wall Street Journal Dollar Index gained 2.2% in April, its best month since November 2016, the dollar remains about 4% below where it was a year ago.
Still, one of the biggest risks for emerging markets is the rising cost of servicing their dollar-denominated debt, which increases when the greenback surges against their local currencies. IIF estimates that emerging markets held a record $6.3 trillion in dollar-denominated debt last year. Among the most vulnerable to the dollar’s rise are Turkey, which has $357 billion in dollar debt, and Argentina, which holds about $231 billion, IIF data shows.
The rising dollar has also helped cool a rally in prices for oil, copper and other raw materials that are key exports of many emerging-market economies.
S&P on Tuesday cut Turkey’s sovereign-debt rating further into junk, citing the country’s debt, rising inflation and volatile currency. Turkey’s main stock market has fallen 2.7% this week, while its currency has declined 3.2%.
Rising U.S. rates can encourage investors to take money out of emerging-market assets, which typically offer higher yields but are perceived as riskier, to invest in safer Treasury bonds. The IIF estimates that investors have pulled roughly $8.4 billion from emerging-markets assets since mid-April.
That comes as investors grow increasingly confident that the Fed will pick up the pace of rate increases. The Fed on Wednesday held rates unchanged at the close of its latest meeting but acknowledged accelerating inflation and strong hiring.
Further currency weakness for emerging markets could send inflation higher, as those countries have to shell out more in local currency to pay for imports. That could force their central banks to raise interest rates at the expense of economic growth.
In an early sign of the mounting pressure on emerging markets, Argentina last Friday lifted its benchmark interest rates to 30.25% to prop up the peso, after its interventions in the foreign-exchange market failed to stem its slide.
Analysts also warn that the strengthening dollar could reignite pressure on China, which has struggled to contain declines in the yuan and outflows from the country during recent periods of dollar strength. On Wednesday, the yuan fell 0.5% against the dollar.
Some investors aren’t giving up on emerging markets yet, citing still-strong economic growth and, compared with past periods of stress, lower ratios of foreign-currency debt to gross domestic product.
Anthony Chan, chief economist at Chase, a division of JPMorgan, is still bullish on Brazilian and Mexican stocks. He believes diminishing trade tensions will provide further support for emerging-market assets.
“If we get good news on the trade front, emerging markets in general will start to recover their recent losses,” he said. “What we’ve gone through so far this year provides even further support for our long-term view that equities and fixed-income in emerging markets are the way to go.”