Dollar weakening good for emerging market assets

Dollar weakening good for emerging market assets
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First Published: Sun, May 24 2009. 11 26 PM IST

Updated: Sun, May 24 2009. 11 26 PM IST
The US dollar is weakening. On Friday, the dollar index, which measures the performance of the dollar against a basket of currencies, went down to 80.04. True, the index had fallen even lower to around 78.5 in the middle of December, but Friday’s reading was the lowest this year and it is well below the high of 89.19 reached on 3 March.
The latest fears about the dollar have to do with rating agency Standard and Poor’s lowering its outlook on the UK from stable to negative. That has sparked fears about a similar change in outlook for US debt, which has led to a big spike in the yields on US government bonds. The US financial press has been full of stories about the collapse of the bond bubble, as government borrowing costs shot up to a six-month high. Stocks, too, fell, as concerns about the outlook for dollar-denominated assets took hold.
If the dollar decline continues, that should provide additional reasons for investors to sell US assets and put their money in non-dollar assets. That shift has already been under way, as investors chase growth in emerging markets while pulling out funds from developed countries. Data from EPFR Global show that in the third week of May, while all equity funds tracked by EPFR recorded collective outflows of $389 million (around Rs1,835 crore), emerging markets equity funds soaked up $2.46 billion.
Also See Depreciation Benefit (Graphic)
Consider also the difference in returns in local currencies and in the dollar from the emerging markets, as shown by the chart. For example, for the three months to 22 May, the MSCI India Index is up 61%, but in dollar terms, it’s up 74.8%. Foreign investors reap the benefit of the depreciation of the dollar. As the chart shows, while returns from the MSCI US Index were 20.4% in the past three months, gains from the Emerging Markets Index in dollar terms were 49.5%. But Chinese assets, with the yuan tied tightly to the dollar, do not really gain from dollar depreciation.
Historically, too, the huge rally in emerging market equities between 2003 and 2007 is correlated with a steep fall in the trade-weighted value of the dollar.
But the dollar has deceived us before. The dollar index had fallen sharply last November and December, before climbing up again. CLSA strategist Christopher Wood views the rise in US treasury yields as a long-term buying opportunity because he does not see inflation coming back anytime soon.
But if the weakness in the dollar is here to stay, that should be another shot in the arm for emerging market assets.
Graphics by Sandeep Bhatnagar / Mint
Write to us at marktomarket@livemint.com
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First Published: Sun, May 24 2009. 11 26 PM IST