So far, the “Trump Bump” has brought a stronger dollar. With an upward-trending US stock market—White House scandals be damned—and planned interest rate increases by the Federal Reserve, the dollar has a strong chance to close 2017 stronger than when it came in. The pickup started after Donald Trump’s surprise victory in last year’s presidential election, and continued almost unabated into April.
The US Dollar Index (DXY)—which measures the value of the dollar against a basket of internationally-traded currencies—topped 100 on November 15 and peaked at 103.21 on January 3. It has since dipped somewhat due to uncertainty surrounding the James Comey scandal, but is still higher than it was for most of 2016. If the media circus surrounding the White House calms down, the dollar should restart its ascent (as should the stock market, which has also dipped over the past week).
A stronger dollar is often viewed as a threat to emerging markets—especially those with high current account deficits and external debt levels. However, conditions vary from country to country, and some emerging markets are better positioned to respond to a stronger US dollar.
The overall picture in emerging markets is improving—last year, a net $7-8 billion dollars flew into emerging market equities, stemming five years of net outflows. Here are some reasons to be optimistic about emerging market performance in 2017.
Dollar Gains Have Already Been Priced In
The “Trump Bump” began immediately after the presidential election last November. Investors have had time to anticipate a stronger dollar and US stock market, so much of the money that would have flown from emerging markets into US equities have already done so.
A Strong US Economy Buoys Global Growth
Rapid changes in capital flows tend to pose problems for emerging markets in which domestic borrowers hold high levels of dollar-denominated debt. When the dollar quickly gains strength against a domestic currency, a credit crunch is likely to ensue.
However, the US is the world’s largest consumer market, and when Americans open their wallets—especially for the purpose of buying imports—emerging markets such as China, India, and Mexico benefit.
The Federal Reserve Will be Cautious
The dollar’s upward trend is partly due to rate increases made by the Fed since late 2015. It most recently decided to raise rates in March, and has signaled it plans to raise them twice more this year. What’s more, the bank still has $4.5 billion on its balance sheet, and would like to gradually reduce that by selling off bonds. Selling bonds means taking cash out of circulation—thereby causing rates to rise.
However, the Fed is being cautious. It opted against increasing rates a second time at its most recent meeting on May 3. A June rate increase is possible. However, annual inflation actually fell to 1.6 percent during March, and according to Federal Reserve Bank of Chicago President Charles Evans, too low inflation is a bigger threat to growth than high inflation. Any further rate increases that come this year will be gradual and can, and will, be anticipated by investors.
Look at the Numbers
Last year was a good one for emerging markets. This year looks like more of the same: the iShares MSCI Emerging Markets ETF (EEM)—which is often seen as a bellwether for emerging markets—increased from 34.20 on December 19 to 41.23 on May 23, even while the US dollar was picking up steam. The EEM includes such companies as Samsung, Tencent, Taiwan Semiconductors and Alibaba.
Even with higher interest rates and stock market expansion driving capital investment in the US, emerging markets look poised for growth. A stronger American economy means a stronger global economy. What’s more, many emerging markets are stronger internally than they’ve been in recent years. Both in the US and elsewhere, things are looking up.