The Dollar and Emerging Markets

Key points:

  • The value of the U.S. dollar has climbed since April, and its rise has been one of the biggest drivers of asset performance in 2018. The stronger dollar is both a consequence of, and catalyst for, tighter financial conditions.
  • The impact has been felt most severely within emerging markets (EMs), although escalating trade tensions have played a role in EM performance. As a result, EM assets have cheapened considerably year-to-date. But rising dispersion underscores the need for selectivity, in our view.
  • We now see limited upside for the U.S. dollar and expect currencies to remain stable for the rest of 2018 barring a material escalation of trade risks.
  • We are constructive on EM equities, with a preference for EM Asia. We see cheap EM valuations, strong earnings growth, and investor underpositioning supporting inflows and equity performance for the remainder of 2018.


The U.S. dollar’s rally, underpinned by strong U.S. growth expectations and widening interest rate differentials versus other economies, has key driver of tighter global financial conditions. The dollar is a central transmission channel for financial conditions, as well as an important measure of risk appetite. As such, softer growth expectations outside the United States in the first half of 2018 combined with the Federal Reserve raising interest rates, led to tighter financial conditions and weaker risk appetite. This impacted EM assets in particular, which, along with concerns over trade tensions, led to a selloff and investor repositioning out of the asset class. The rise in short-term U.S. rates beyond the rate of inflation has provides a nascent alternative to risky assets, and in our view has led to a longer drawdown. However, the EM selloff has slowed, the U.S. dollar has stabilized and EM valuations have cheapened, creating potential attractive entry points.

Cross-asset impact

The dollar is the nexus between asset classes. It affects borrowing costs and commodity prices, is a proxy for risk appetite, and influences global capital flows.1However, the dollar’s impact, while global, is unevenly distributed: country fundamentals also matter and are increasing the dispersion of country equity markets. For example, this year, EM countries with large financing needs, such as Turkey and Argentina, saw the greatest jump in borrowing costs and steepest foreign exchange (FX) losses. Countries with strong balance of payments saw their currencies and borrowing costs largely contained.