Weakening dollar fuels optimism for energy, emerging markets
By Godwin Anyebe
The US dollar has already dropped over seven per cent against a basket of major currencies this year. The decline has been unusually rapid and shows no signs of stopping, driven by a combination of slowing U.S. growth, trade tensions, and an expectation that broad layoffs will result in further easing from the Federal Reserve.
The fourth straight monthly decline in consumer sentiment, reaching the lowest level in four years, would suggest that the Federal Reserve may already have fallen behind in the cutting cycle. All these factors driving US dollar weakness are now converging at once, and while a declining US dollar sounds scary, it has historically supported significant global growth.
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Traders will remember a similar dynamic in the early 2000s when a weaker greenback coincided with an unprecedented boom across developing economies and resource markets. The dollar is the currency of choice for foreign exchange transactions and anchors most global central bank reserves. It is also the most common pricing benchmark for everything from commodities to corporate and country-level debt.
These two last items make emerging markets, in particular, highly sensitive to the dollar’s movements. For every foreign company and country that borrows in greenbacks, a steadily stronger dollar makes those debts more expensive to service. A weaker dollar, by contrast, lowers local currency repayment burdens and frees up fiscal space. That easing effect is now taking place globally again as the dollar declines.
These dynamics are already showing in the numbers. So far this year, emerging markets have significantly outpaced the S&P 500. Currency markets are moving too. The euro has strengthened to $1.14, while the Japanese yen, long viewed as undervalued, is making a comeback. Even the Mexican peso, battered last year by U.S. tariffs, has recovered on the back of strong remittances and nearshoring trends.
In a February note on fixed income, the team at Morgan Stanley referenced that “continued US dollar weakness would be a positive tailwind for EM currencies.” Reduced foreign exchange risks, emphasised by large institutions, also provide easier access to capital for emerging markets since investors no longer demand to be compensated for potentially outsized foreign exchange moves. This lowers the cost of capital for emerging market companies, allowing them to invest more. Increased investment means more consumption of global commodities such as oil, similar to what energy investors fondly remember from the early 2000s.
Michael Cornacchioli, the Investment Strategy Director of Citizens Private Bank, has also flagged this trend, writing that “A weakening U.S. dollar has historically served as a tailwind for international equities. Prolonged dollar depreciation in the late 1980s post-19877 U.S. stock market crash) and the early 2000s (dot-com bubble) coincided with significant international outperformance. A weaker dollar enhances financial conditions within emerging economies, reducing import costs and easing the burden of servicing dollar-denominated debt.”
A lower US dollar also allows for stimulus in emerging markets, as those governments can relax conditions without having to worry about creating undue pressure on their currencies. Samuel Bentley, at Eastspring Investments in Singapore, has written about this before, saying “the recent US-led rate cut cycle opened a window of opportunity for China to launch pro-growth policies. The latest support package for the property and stock markets marks the first major coordinated easing in years.”
