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How the Weakening Dollar Positively Affects Emerging Markets

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Time to get back in?

For investors wondering how to interpret the activity around emerging markets, we examine four major factors driving the recent rally—and the markets we believe are most likely to be impacted by each.

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U.S. Dollar weakness

The Federal Reserve’s dovish stance on interest rates has taken some air out of the U.S. dollar relative to other currencies. For countries with large current account deficits, a weakening dollar can provide relief both in the cost of financing and in trade. We see this potentially benefiting Brazil, Indonesia, Turkey, South Africa and India.

Market Realist – Dollar weakness could be positive to some emerging markets

The dollar weakened against most of its major peers as markets saw only a low probability of a US (IVV) (IWD) rate hike in April. The dollar’s fall was exacerbated after policymakers took a dovish stance on the interest rate hikes at the March meeting. The Bloomberg Dollar Spot Index, which tracks the currency versus ten peers, has weakened 4.2% to 1,200.1 from its yearly high of 1,253 recorded on January 22. The emerging markets currencies have also appreciated against the dollar. The Chinese yuan strengthened by around 1.5% against the dollar this year and is currently trading near its best levels at 6.4. Similarly, the Indian rupee appreciated by 2.8% from its high recorded in February 2016.

The appreciation of emerging market (EEM) (IEMG) currencies against the dollar bodes well because when a currency strengthens, imports get cheaper, which leads to lower prices and ultimately more money in the hands of the consumers (IYC). For countries with large current account deficits, a weakening dollar can help reduce the trade deficit. South Africa has a current deficit of 5.1% of GDP (gross domestic product) for the quarter ended December 2015 followed by Turkey at 4.5%, Brazil at 2.7%, Indonesia at 2.4%, and India at 1.3%.

An appreciating local currency can also lead to higher investment returns for foreign investors because it takes less of that currency to translate back to US dollars.

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