Why Weaker Dollar & Low Crude Oil Could Push EM Higher

Emerging markets are countries that have demonstrated significant growth in the past few decades. In the past few years, these countries have become the focus of investors because they expect them to continue overperforming. In the past, terms like BRICS (Brazil, Russia, India, China, and South Africa) have been coined to illustrate the best-performing EM countries. In 2018, EM countries were hit hard by a number of factors.

First, while a strong dollar made it better for them to do external business, it has some drawbacks. For example, with US rates rising, investors in EM countries took their money out of the EM countries to where the yields are better. This limits the foreign direct investments in these countries. Second, most of these countries have a lot of dollar-denominated debt. A stronger dollar makes it more expensive for them to repay their debt.

In 2018, emerging markets had a tough period with most of them seeing their currencies depreciate against the USD. The chart below shows the performance of a number of EM currencies in 2018. The decline in the EM currencies was mostly because of a strong dollar, which was so because of the continued Fed tightening. Another reason was the impacts of the trade war, which affected global growth. Another less-talked issue was on the US tax cuts, which led to capital flight from these countries to the United States. With business conditions being better in the US, a number of companies preferred being invested there.

(Click on image to enlarge)

As you can see, the Turkish Lira was among the worst performers. At its worst, the currency dropped by more than 80% against the USD. This was because of the above factors. Another reason was because of the continued arrest of an American pastor. This led to more tariffs from the United States. When he was freed, and the role of Turkey in aiding the investigation of the murder of Jamal Khashoggi led the currency to improve slightly.

In the coming year, the Emerging Market countries could perform better. This is because there is a likelihood that the world will have a truce on trade. Already, US and Chinese officials are negotiating on how to address the key differences. A deal will lead to more trade and more confidence among businesses. Second, there is a likelihood that the USD has peaked. This is because the Fed will likely pause on more interest rate hikes. Already, the Fed chair has said that the neutral rate is approaching. This coupled with the increased volatility in the market could lead the Fed to halt or slow the rate hikes. Third, and most importantly, with EM stocks being oversold, there is a likelihood that a number of international investors will go to bargain hunting. This will likely see flows in these markets rise. Finally, the low crude oil prices will continue providing support to the countries.

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