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The Dollar’s Exchange Rate Is Hurting Emerging-Markets Currencies
Strong U.S. dollar is starting to weigh on South African rand and Brazilian real.
By Julia-Ambra Verlaine of The Wall Street Journal
A strong U.S. dollar is now whacking emerging-markets currencies.
Money managers are selling the South African rand and Brazilian real, reversing a trend earlier in the year when the sharpest commodities rally in modern trading history supported emerging-markets currencies despite a strong dollar. The rand and the real both declined more than 9% against the dollar over the last three months. At the start of April the rand was up more than 8% year to date and the real was up more than 17%.
That is because investors are now focusing on potential global stagflation, a phenomenon where economic growth slows while consumer prices rise. Commodity prices have also eased, with oil, soybeans and copper coming off recent highs.
“The narrative has shifted since the end of May,” said Steve Englander, head of North America macro strategy at Standard Chartered PLC. “The story of muddling through on growth and strong commodities demand has shifted to increasing fears of a slump.”
Worries about runaway inflation and a potential recession have whipsawed financial markets throughout June. Investors are questioning whether the Federal Reserve can raise interest rates just enough to slow down inflation but without throwing the economy into a recession. This month, the Fed upped interest rates by 0.75 percentage point, its biggest increase since 1994.
One result is that the dollar has surged to multidecade highs this year, pushed higher by investors searching for protection against disappointing stocks and bonds. Short-term interest rates have also increased abruptly, tightening financial conditions for corporations that borrow to fund operations.
All that has spurred investors to unload assets that tend to perform poorly during periods of lower growth. Asset managers typically consider emergingmarkets assets as higher risk than developed market bonds such as German bunds and U.S. Treasurys.
The WSJ Dollar Index, which measures the dollar against a basket of 16 currencies, is up nearly 2.5% so far this month and nearly 12% over the past year.
“The strength of the dollar recently reflects a worsening external environment and tighter financial conditions,” said Nafez Zouk, an emerging markets sovereign debt analyst at Aviva Investors.
The U.S. dollar functions as the world’s reserve currency and is used for trading commodities in the global economy. A stronger dollar often hurts emerging-markets economies by weakening their currencies and spurring inflation in those countries. It makes importing foreign goods more expensive, offsetting the benefits of cheaper exports. It was an anomaly when the dollar strengthened earlier this year and emerging markets currencies continued to rise.
Central banks in emerging markets economies have been raising interest rates to combat inflation and keep pace with the Fed. This typically supports currencies because investors favor countries where the central banks show a willingness to fight inflation and pay higher interest rates on debt.
This time, though, investors are wary that sharply higher borrowing costs could spark a recession in those countries. The Bank of Mexico raised interest rates to 7.75% Thursday in a ninth consecutive increase. The Brazilian central bank’s monetary policy committee, known as the Copom, lifted its key rate from a record low 2% early last year to its current 13.25%, the highest since 2017.
The Brazilian real, once a favorite among asset managers because of Brazil’s status as a leading commodities exporter, has been pushed aside as elections loom and inflation continues to rise. Wall Street traders said the currency usually experiences swings leading up to elections that investors are seeking to avoid.
The Chilean peso, which benefited earlier in the year because Chile is one of the largest copper producers in the world, reached all-time lows against the dollar. The sharp move lower has forced some investors who were holding pesos to sell the currency to mitigate losses, according to traders at Wall Street banks.
Traders said investors are beginning to buy the Mexican peso again after the currency lost more than 5% over the past month.
Analysts say currencies backed by economies with high value commodity exports, such as copper and oil, can cushion the effects of high prices for the food and energy they have to import. They expect these currencies, such as the Chilean peso, will eventually outperform other emerging-markets currencies. Investors gauge the value of emerging markets exchange rates by scrutinizing trade balances and deficits. Rising import costs frequently increase a trade deficit, or reduce a trade surplus.
“Concerns about food security and inflation are likely to remain elevated,” wrote Barclays strategists in a note to clients. “Markets will continue to differentiate between exporters and importers.”
