Emerging markets remain stable despite weaker US dollar and tariff uncertainty

• James Syme
  Senior Fund Manager
  J O Hambro

The volatility in global financial markets continued to ramp up. Notably, this included US financial markets, which exhibited a general pattern of a softening US dollar and rising bond yields. While some analysts have described this as a “classic emerging market crisis,” as veterans of actual emerging crises dating back to 1994, we consider this a wildly overstated perspective. From the end of February to the end of April, US sovereign 10-year bond yields were highly volatile, but ended flat at 4.2%, while US 30-year yields rose from 4.5% to 4.7%. What was particularly unusual was that these market moves were accompanied by a weaker US dollar: the DXY index of the dollar against major currencies fell 7.6% in the period, while the broad trade-weighted index fell 3.9%.

To highlight the degree of abnormality of these moves, there have only been four other occasions in the last 30 years in which the US dollar fell by more than 1.5% when 30-year yields rose more than 10 basis points. Those were during the Global Financial Crisis in February 2009, during the European sovereign debt crisis of October 2011, the May 2013 temper tantrum, and the first election victory of President Trump in November 2016. Yields on US 30-year Treasuries rose in the period, but the increased interest rate demanded by investors is not due to inflationary expectations, as inflation-protected bond yields also ended the period higher.

Emerging market currencies gain against the dollar

There is an idiom that states “when the US sneezes, the world catches a cold.” Given the current volatility and weakness in core US financial markets, how have major emerging markets fared? From the end of February to the end of April, the currencies of nearly all emerging markets strengthened against the US dollar (the four Gulf states with US dollar pegged currencies have been excluded from this analysis, as has Greece, which uses the Euro). The strongest was the Hungarian Forint, up 8.6%, while the weakest was the Indonesian Rupiah, down by a marginal amount.

In addition, the bond yields (looking at local currency bonds with a maturity closest to 10 years) of the majority of major emerging markets declined. For the very biggest emerging markets, the combination of moves was particularly positive. Brazil saw the currency gain 3.7% and 10-year bond yields decline 1.2 percentage points; in India, those figures were +3.6% and -0.4pp. Despite the prospect of US tariffs, major exporters generally fared well. Currencies strengthened and bond yields declined in Mexico (+4.8%, -0.1pp), South Korea (+2.4%, -0.1pp), and Taiwan (+2.9%, -0.1pp). China (currency marginally weaker, bond yields marginally higher) was the only significant exception. We feel that the best explanation of this seemingly confusing set of market signals is that some global investors are relying less on the US dollar and US sovereign debt as their risk-free benchmarks — whilst the US dollar was down 7.6% against major currencies, it was down 15.1% against gold.

International capital flows and trade drive emerging markets

Emerging markets are driven by two major global drivers: international capital flows and international trade. A weaker dollar represents capital flowing out of the US and into the rest of the world, and a weaker dollar has consistently been positive for emerging markets over the last 30 years. Although evolving tariff policies threaten a downturn in global trade, the message from financial markets is that global investors’ uncertainty about US economic policies is a clear positive for emerging economies and for investors in emerging markets.