Currencies: Why the U.S. dollar’s relentless rally is causing pain for emerging markets
There’s just no stopping the surging U.S. dollar.
That might mean more pain for emerging markets until the global spread of the COVID-19 pandemic and the accompany market volatility begins to subside, despite the Federal Reserve’s efforts to respond to a seemingly insatiable global demand for dollars.
The Fed on Thursday announced the creation of additional swap lines to provide dollar liquidity to nine countries — Australia, Brazil, Denmark, South Korea, Mexico, Norway, New Zealand, Singapore, and Sweden — in an effort to meet heavy demand for dollars around the world.
“While the additional swap lines announced by the Fed today seem to have given respite to a few embattled currencies, they may not be sufficient to stop the dollar in its tracks. We think that the greenback will not weaken by much until the wider turmoil in the markets starts to ease,” said Oliver Allen, economist at Capital Economics, in a note.
The ICE U.S. Dollar Index
a measure of the U.S. currency against a basket of six major rivals, jumped another 1.5% to a more-than-three-year high Thursday. The dollar has jumped 3.9% this week alone against the basket and 4.5% for the month. The Fed on Sunday announced it had acted in concert with other major central banks to lower the interest rate on existing swap lines.
A rapid rise by the dollar can be a double whammy for emerging markets where businesses borrow heavily in U.S. dollars and are dependent on exports of commodities that are priced in dollars. Brazil, Russia and Mexico have seen their currencies plunge this week in a move that underlines a vulnerability in emerging markets, said Jeffrey Kleintop, chief global investment strategist at Charles Schwab, in an interview.
The dollar has risen more than 5% versus the Brazilian real
this week and is up 9.2% versus the Russian ruble
and more than 11% against the Mexican peso
The dollar weakened 2% Thursday versus the Russian ruble, aided by a sharp rebound in oil prices.
Emerging market businesses borrow heavily in U.S. dollars since many have substantial dollar-denominated revenues. In response to the pandemic, businesses have moved to draw down credit lines in an effort to secure as many dollars as possible to ensure they can meet dollar liabilities, Kleintop said.
But the ability of swap lines to meet that demand appears limited. Moreover, the U.S. doesn’t have swap lines with many important emerging market countries, perhaps most notably, China.
Meanwhile, the strain of a soaring dollar on emerging market businesses and economies is a big part of the reason why emerging-market equities have underperformed during the global market rout, Kleintop said.
The iShares MSCI Emerging Markets ETF
remains down nearly 14% this week versus a 10% fall for the U.S. benchmark S&P 500 index
Year-to-date, EEM is down more than 23% versus a 20% fall for the S&P 500.
While EEM is weighted toward China and South Korea, which have seen a peak in cases and a rebound in equities, worries about other countries and dollar sensitivity have been a drag, Kleintop said.
Allen said the sudden scramble for dollars echoes 2008, when the dollar rose sharply as funding markets froze up. If the comparison holds up, the dollar might not weaken until markets calm down.
“The peak of the dollar during the [Great Financial Crisis] coincided not with the Fed’s swap programs, but with the trough in the S&P 500, by which time the worst strains in money markets had eased,” he wrote. “And while action by policy makers helped put a bottom under the markets in 2009, fiscal and monetary policy cannot cure a pandemic. A sustained retreat of the dollar may have to wait until the coronavirus outbreak shows clear signs of fading.”
And when that happens, emerging markets might be the first thing to rebound, Kleintop said.
“I think [emerging markets] could be the first thing that snaps back as we see the coronavirus fade,” he said. With the U.S. headed toward a fiscal stimulus of more than $1 trillion and the Fed having cut its policy interest rate to zero, there will be some downward pressure on the dollar once the turmoil subisdes, which could help pave the way for an emerging market rebound.