The warning from deVere Group's Nigel Green follows news that that the producer price index (PPI) in the US rose more than expected in February, coming just days after data showed an unexpected rise in consumer prices (CPI), has slashed the likelihood of imminent rate cuts by the Federal Reserve.
He comments: “The PPI in the US strengthens our position that the Fed is almost now certainly not going to cut rates this month; and we now believe it could delay cutting rates until the third quarter of the year.
“This would continue to strengthen the dollar and impact emerging market currencies.”
“Many emerging market countries' governments and corporations borrow in US dollars, when the dollar strengthens, the cost of servicing this debt increases for these borrowers because they need to convert more of their local currency into dollars to repay their obligations.”
This can strain government budgets and corporate balance sheets. For example, if the dollar strengthens against the Brazilian real, Brazilian companies with dollar-denominated debt will face higher repayment costs.
A strong dollar can also trigger capital outflows from emerging markets as investors seek higher returns in U.S. assets.
“This typically leads to depreciation of emerging market currencies as demand for them decreases. For example, if investors believe that the U.S. economy is performing better than emerging market economies, they may move their investments out of emerging market assets, causing the local currencies to weaken.”
This happened during the "taper tantrum" in 2013 when the Federal Reserve hinted at reducing its bond-buying program, leading to capital outflows from emerging markets and currency depreciations.
In addition, emerging market countries rely on exports for economic growth. When the dollar strengthens, emerging market currencies weaken in comparison, making their exports more expensive for foreign buyers. This triggers “a decrease in export volume or a loss of competitiveness in global markets.”
A weaker local currency resulting from a strong dollar can also lead to inflationary pressures in emerging market countries. “This is because imports become more expensive, which can drive up the prices of imported goods and raw materials. For example, if the dollar strengthens against the South African rand, South Africa may experience higher prices for imported commodities, impacting overall inflation levels.”
The last mile to reach the Federal Reserve's 2% inflation target seems to a slow one and, as such, deVere expects high-for longer rates.
There is also a legitimate narrative that the Biden administration will push to maintain a strengthening dollar this year as the US holds presidential election in November.
A robust dollar enhances consumer purchasing power and bolsters investor confidence, pivotal factors for a thriving economy. By maintaining a strong dollar, the administration aims to showcase economic stability and competence, potentially bolstering voter sentiment.
“This all means a stronger dollar which is challenging for emerging market currencies, as a strong greenback can lead to economic instability, higher borrowing costs, reduced competitiveness, and inflationary pressures in these countries,” concludes Nigel Green.
