Unrelenting Dollar strength throughout the year has whittled away at broadly positive expectations for emerging markets in 2022. With the Fed raising rates at double the pace of their previous rate hike cycle and longer-term yields on US Treasuries rising rapidly, the greenback looks set to remain dominant. Many emerging market economies are carrying significant loads of Dollar-denominated debt, which becomes increasingly difficult to service as the USD rises against local currencies.
China’s Yuan has experienced a particularly rapid depreciation against the Dollar in recent months. That indicates weakness in the Chinese economy and is a foreboding signal for emerging market economies that are reliant on their commodity exports. China is the largest consumer of commodities in the world and a slowdown there will likely reverberate throughout the markets they typically purchase from.
Related ETFs: iShares MSCI Emerging Markets ETF (EEM), iShares MSCI Emerging Markets ex China ETF (EMXC), iShares MSCI Emerging Markets ex China ETF (EMXC), WisdomTree Emerging Currency Strategy Fund (CEW)
Emerging market stocks begun the year with high hopes. Just five months into the year, that resurgent optimism has largely been derailed.
As MRP highlighted back in January, JPMorgan’s equity analysts expected emerging market equities would return 18% in 2022 thanks to a combination of corporate earnings growth and fading fears that the Chinese regulatory clampdown will escalate and broaden. At the same time, Bank of America’s fund manager survey indicated that emerging market stocks are expected to produce the best returns of the coming year.
That outlook has not materialized. MSCI’s main emerging market stocks index, covering 24 economies, fell to its lowest level since July 2020 on Monday. Part of the downturn can be chalked up to general volatility across all sectors of the equity market, as well as Russia’s invasion of Ukraine in February, which MRP noted could have an outsized effect on emerging markets. However, the most significant headwind for emerging economies is likely the unrelenting rise of the Dollar.
Since declining to a trough of 90 around this time last year, the US Dollar Index (DXY) has enjoyed a nearly non-stop 15% rally, closing in on 104 this week. That rise marks a nearly 20-year high for the DXY, posing a particular risk to emerging markets. In the same way that US corporate earnings can be boosted when the Dollar depreciates vs foreign currencies, Dollar-denominated debt declines in value.
Conversely, as the Dollar strengthens, it becomes more expensive for foreign borrowers to service and repay their Dollar-denominated debt. As of 2019, about two-thirds of external debt of emerging market economies was denominated in USD. In 2020, Dollar-denominated debt in emerging markets rose past $4 trillion for the first time. By the end of 2021, median foreign-currency government debt in emerging markets stood at a third of GDP, Fitch estimates, compared to 18% in 2013. Until the Dollar peaks, this debt load will…
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