The dollar remains strong but other currencies are strong too.
The strength of the dollar against many developed market currencies so far this year has caught many corporate treasurers by surprise, particularly since the Federal Reserve has promised to be patient with future rate hikes. Yet the even stronger rally by emerging market currencies, such as the Russian ruble and the Brazilian real, was more predictable.
A dovish Fed and relatively higher yields in emerging markets [EM] have heightened the appeal of emerging market assets. In addition, inflation in emerging markets has remained low.
“EM inflation remains extremely well-behaved in spite of last year’s 9% slide in EM currencies,” says Jan Dehn, global head of research at Ashmore Investment Management. “Most EM central banks are now very credible inflation fighters, so inflation expectations do not unravel, regardless of what happens to FX.”
Exchange-rate pass-through—the impact of exchange rate fluctuations on domestic inflation—only tends to be an issue in a few countries that have not managed to establish monetary policy credibility, such as Argentina and Turkey, Dehn says.
The best-performing emerging market currencies in the year to date through mid-February were the Russian ruble (up 5.9%), the Brazilian real (up 4.6%), the South African rand (up 4.3%), and the Colombian peso (up 3.9%), according to Thomson Reuters Datastream.
While many emerging market strategists are predicting that emerging market assets will outperform the US in the first half of 2019, the overall slowdown in global growth remains a concern. “The slowdown in growth in the emerging world this year is likely to be unusually broad-based,” says William Jackson, chief emerging markets economist at Capital Economics. “That will set a downbeat mood for EM assets over the course of this year.”
The economies of the eurozone and China are already exhibiting slower growth and the US economy is likely to soften later this year, Jackson says. In addition, commodity prices are low and most of the large emerging markets—China, India and Russia included—have already passed peaks in their economic cycles, Jackson adds. The environment for the financial markets of these countries will be difficult, he says.