People Are Still Sleeping On This Rally

People Are Still Sleeping On This Rally
Reda Farran, CFA

3 months ago2 mins

Earlier this year, their strengthening currencies were the big argument in favor of investing in emerging markets (EM). After all, when EM currencies strengthen relative to the dollar, that increases the returns for foreign investors, since their gains become even more valuable when converted back into their home currency. But, let’s face it: that’s not turning out to be such a good argument.

The MSCI Emerging Markets (EM) Currency Index dropped 0.8% last week, virtually wiping out all of its 2023 gains. There are a few factors driving that decline.

First, traders increasingly have been betting that interest rates in the US will stay high for a while. That makes the big, safe US dollar more appealing compared to other currencies, especially riskier EM ones.

Second, China’s economic troubles have sent the yuan to a 16-year low against the dollar. That has a massive impact on the EM currency index because the yuan, with its 30% weight, is the benchmark’s biggest component. China’s economic downturn, meanwhile, is also reverberating throughout other EM economies, laying their currencies low as well.

Third, signs of stagflation (that’s a bitter blend of high inflation and low or negative economic growth) are starting to emerge in Europe, and that’s had investors shunning the region’s assets, including the currencies of its EM members.

Fortunately, there were a few other arguments in favor of investing in EMs – and they seem to be holding up (for now). For one, EM stocks are cheap and would, along with EM bonds, benefit from the rate cuts that are expected by their central banks later this year. For another, EM governments are adopting investor-pleasing policies, and are seeing their economies grow faster than advanced ones. And finally, emerging economies that aren’t China are benefiting as companies in the West seek to limit their exposure to the country.



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