The prospect of a trade war slowing down the world’s economy means investors have been reassessing where to put their money.
In recent weeks, developing market currencies like the Turkish lira and Argentina’s peso have fallen to their weakest levels in months against the US dollar.
For the time being, the US Federal Reserve is the only major central bank raising interest rates, and that’s lending support to the dollar.
At a central bank conference in Portugal this week, the US Federal Reserve chairman said the case remains strong for more US rate increases – which means trouble ahead for those countries borrowing in dollars.
After the end of the global financial crisis, record low interest rates in the US meant many developing nations borrowed in dollars. And as the dollar rises, it’s now costing those developing countries a lot more to repay their debts.
So, is the dollar to strengthen further? And how big an issue is it for emerging market economies?
Timothy Ash, a senior emerging markets sovereign strategist with London-based BlueBay Asset Management, explains why, for some economists, it’s raising alarm bells.
“I think the consensus is beginning to emerge that the dollar will probably end up being a winner from the trade wars … helped also by the assumption of weakness in the eurozone … It does look like the dollar is on an appreciating trend,” says Ash.
“It means more pressure [for emerging markets] … The assumption was … as long as global growth stayed fine, then on the revenue side emerging market countries would be more than able to cope with higher DM and US rates.”
But, according to Ash, “what’s changed in terms of perceptions has been the dollar rally, that obviously increases debt service costs in hard currency, in dollars from the emerging market countries. And the other one has been concern about trade wars and what that means for global growth.”
“So, you put all those together: Fed tightening, dollar’s strength, trade wars and prospects for global growth weaking a bit – and also fairly difficult bottom-up stories in many big emerging market countries … You’ve got elections looming this weekend in Turkey, you’ve also got elections in Mexico, Brazil … There are significant reform challenges … It’s very challenging environments for emerging markets.”
