The stronger US dollar and rising US bond yields present a “double negative” for emerging markets (EM), according to Natixis Investment Managers.
The combination of both factors often led to investors disposing of their EM assets but the firm said EM currencies were already recovering and there was little room for US dollars to strengthen further.
Esty Dwek, head of global market strategy at Natixis IM, said: “A stronger dollar typically leads to capital outflows and higher servicing costs (in local currency terms for hard currency sovereign debt). In addition, a stronger dollar could lead local central banks to hike sooner to support their currencies, chocking off the recovery.
“However, we do not expect this to be the case, as the dollar should not strengthen much from here and EM currencies are recovering from already low levels. As such, we are likely to see only gradual hiking as inflationary pressures should remain contained once base effects and higher commodity prices work themselves through.”
Other hurdles for the region included ongoing COVID-19 problems, especially in India and Brazil, a deceleration of growth in China, a slow re-opening of global travel and regulation problems with Chinese technology firms.
However, it was not all bad as the situation facing EMs was being handled from a better position than previous crises.
Dwek identified Mexico, South Korea and Taiwan as places that could emerge positively from the pandemic. Both the MSCI Taiwan and Korea indices had returned more than 50% over one year to 25 May, 2021, while MSCI Mexico returned 33.7%.
“EM economies are not in the same position as they were during past crises. Their debt and deficit levels are generally lower (with regard to pre-COVID spending) and they have become less exposed to moves in the US dollar since local currency debt issuance has grown for sovereigns. Leverage levels have improved, though banking systems are not particularly healthy,” Dwek said.
“Also, they have generally been less fiscally expansionist than the developed world in response to the pandemic.
“We are more cautious on the segment, though we still believe these are attractive entry points for the long term. As US rates and the dollar stabilise, the global reopening progresses, and EM vaccination accelerates, EMs should quickly do better again.”
