The dollar is on the rise and for all it’s worth, this is good national news. The rising US yields, however, have both a direct and indirect negative impact on emerging markets. One doesn’t have to be an economy seasoned expert to understand that. Since the dollar is one of the most dominant currencies in the world and especially in global trading, its spikes also influence emerging markets. Why? Because they depend on dollar-denomination bonds. After the elections, the rising US yields affected international currencies and had emerging markets left with little to rely upon.
A Little Bit of History on the Post-Election Impact of Rising US Yields on Emerging Markets’ Currencies and Stocks
Right after the elections, the surging dollar weighed on emerging market assets – this is not a new phenomenon, as every U.S. presidential election causes imbalances of the stock market and disruptions of foreign currencies. This is what happened:
- The Mexican peso led the falls across currencies with a 5 percent slip against the dollar, while stock markets chalked up solid losses. The Mexican peso is today the distress signal of market anxiety, therefore this particular fall showed that nothing good was coming ahead.
- Russia’s ruble and the Turkish lira traded 1 percent weaker. Their stocks fell around 0.8 percent.
- Malaysia’s ringgit traded near 10-month lows while China’s yuan slipped only 0.5 percent against the dollar, but Asian markets tallied up heavy losses in the same period of time.
- Countries in Central and South-East Europe saw their currencies hovering broadly flat against the euro.
The instability on the currency exchanges and stock markets were heavily dominated by global uncertainty. Nobody knew what the new president was going to do. The Republican economy-revamping plan including the Border Adjustment Tax and the tensions between the U.S. and China kept everybody on their toes. They still do.
For now, we can still hope the BAT is going to remain just a theory and not become a fact. Still we do have to deal with one fact: a fresh spike in the U.S. Treasury yields led to an emerging markets stocks’ fall down to more than 1%. Simultaneously, the oil prices’ plunge to three-month lows had the power of a shockwave across many developing countries.
Now Back to Present Days
What we know now is that the U.S. 10-year yields are at their highest level since the end of last year. The dollar rose as a consequence of data suggesting that the Federal Reserve might consider tightening policy. Such phenomena again led to plenty of disruptions among emerging markets:
- Hong Kong, Taiwan, China and Poland lost in bourses as much as 1.2%.
- The Russian dollar-denominated stocks dropped almost 3% to three-month lows, severely damaged by a 5% fall in oil prices.
- The South African rand dropped around 1% against the dollar. Likewise, the Turkish lira dropped 0.5%. Thus, both currencies almost caught up to their one-month lows.
What Should We Understand from this Data?
Simply put, the rising US yields are growing so fast since the Trump election that less liquid emerging markets’ bonds aren’t capable of keeping up the pace. There are clear signs of premium squeezes. Still, that’s not because investors are avoiding asset class-centric risks. It’s because they cannot sell fast enough. Simply put, rising US yields become a threat for emerging markets and a pain for investors.
In a perfect world, however, investors should see the present strength of the U.S. dollar as a welcomed outcome propelling emerging markets. This strength should be compelling investors to seize the buying opportunities. Yet,buying isn’t really the issue here but the selling. Let’s take a closer look at how the rising US yields have an impact on emerging economies.
The Impact on Emerging Economies
Just like President Trump wished for, the American economy is stepping up its game in its relationship to the rest of the world, feeding the dollar run. But as the USD appreciates more, the harder it becomes for emerging markets to cover their dollar-bound short-term debts. Plenty of countries and institutions will have a hard time meeting their U.S. dollar-denominated obligations. As we said before, the strength of the USD can weaken emerging economies by generating a feedback loop with the currency market.
Sovereigns like Mexico, the BRICS countries, Central and South-Eastern countries and some of the Asian markets may find themselves on the brink of another economic crisis. Their currencies may be crushed to the ground by exchange rates and interest rates.
The biggest impact of the spiking dollar is, just as always, felt deep by the end-consumer. People don’t always understand the relationship between oil and bonds. However, they will understand:
- higher prices in refined petrol products;
- higher prices of agricultural products (directly influenced by the oil stock prices);
- the struggle of making ends meet (especially in the countries depending directly on U.S. financial aid, such as Turkey or Venezuela).
Containing the Dollar – The Wiser Option?
What needs to be understood at this point is that the spiking dollar can create a vicious cycle with negative effects on America itself. U.S. companies relying on the demand of emerging markets may feel squeezed – especially the consumer-goods ones. Exchange rates fluctuations and emerging markets weakened buying capabilities can lead to such companies’ losses in revenue.
Another piece of the puzzle to watch out for is the interest-rate hike which can make it hard for U.S. companies to issue bonds. Such a phenomenon, mixed with higher interest rates might convince foreign investors to look elsewhere, as U.S. corporate bonds may appear less and less appealing to them.
Is Everything as Grim as Predicted?
It would be farfetched to consider that the rising US yields will constantly hit emerging markets to the point of erasing them from the face of the Earth. Financial analysts consider that things might find their balance after an adjustment period. While the rising dollar does influence the oil market, global trade, stock movements, foreign investments and so on, such a state of facts will not hold forever.
A 0.25% increase in the federal funds’ rate isn’t, at a first glance, the most spectacular thing that happened this year. However, this spike will definitely impact global trading. Russia and Brazil are worth watching out for as being particularly vulnerable. But, as specialists say, emerging economies are not all the same. Each has its own fair share of strengths and opportunities. The provisions for 2017 are, in fact, quite optimistic.
So let’s assume the American president moderates his views on Border Adjustment Tax, the trade tariffs, and the American position in NATO. Then, the rising US yields’ impact on the long term should be easily mitigated.
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