Nicholas Spiro

Macroscope | How the US dollar could turn emerging market fortunes around if the Chinese yuan maintains its value

Nicholas Spiro says a stabilising US dollar and the sell-off in emerging market stocks last quarter means developing economies could be attractive once again

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An Indonesian employee counts US dollar banknotes at a money changer in Jakarta, Indonesia, on May 8. The strengthening US dollar over the past month hit emerging market currencies hard. Photo: EPA-EFE

Nicholas Spiro

Published: 2:00pm, 12 Jul 2018Updated: 10:29pm, 12 Jul 2018

The last quarter was one that emerging market investors would rather forget. According to Bloomberg, the currency, equity and bond markets of developing economies suffered their worst three-month period since the third quarter of 2015 when emerging market assets bore the brunt of the sell-off stemming from the surprise yuan devaluation.

A toxic combination of an abrupt tightening in financial conditions, an end to the period of synchronised global growth and a dramatic escalation in tensions over international trade has led to a sharp deterioration in market sentiment. According to data from JPMorgan, emerging market bond and equity funds have suffered outflows for the past 11 weeks, while the JPMorgan Emerging Market Currency Index, a leading gauge of currencies in developing nations, plunged 9 per cent last quarter, its sharpest fall since 2011.

Yet, over the past month or so, the most important financial vulnerability in emerging markets has become less acute. The rally in the US dollar has lost momentum and has even begun to unwind slightly. While the dollar index, a measure of the performance of the greenback against a basket of other currencies, surged 6 per cent between mid-April and the end of May, it has since proved volatile, and has fallen a tad since the end of last month.

To be sure, it is too early to call time on the dollar’s ascent, not least given the increasingly hawkish signals from the Federal Reserve. However, the recent stabilisation of the greenback is noteworthy and, if sustained, could help turn the tide in the outlook for emerging markets – especially given the fact that valuations in developing economies are starting to look more attractive following several months of sharp price declines.

The main reason the dollar’s rally has stalled is the sudden rebound in Europe’s economy, particularly in Germany. This is allaying fears that the recovery in the euro zone was in danger of being snuffed out. In a report published last Friday, JPMorgan noted that Europe has supplanted the US over the past several weeks as the region where economic data is beating market expectations, challenging “the presumption of US economic exceptionalism.” The stronger data out of Europe has lifted the euro, putting the dollar under strain.