Research Affiliates, the California-based smart-beta manager, has produced an interesting paper questioning several key assumptions about the relationship between the US dollar and the economic and market performance of emerging markets. Is the stronger greenback really bad news?
The paper says there are three ‘myths’ which investors often believe are true:
> Higher US yields will only cause more troubles to emerging economies
> A stronger dollar will exacerbate emerging market macroeconomic struggles, and
> Emerging markets are as likely now as they were in the past to experience a deep economic and financial crisis.
The paper, by Michele Mazzoleni, says that the myths tend to be based on the stated views of economists and may make intuitive sense, but they do not reflect the empirical evidence. He says that the markets have been punished recently by sentiment and a fluctuating developed market’s risk appetite.
Mazzoleni says: “Without fear, there are no signs, once again, history might be repeating itself.” He highlights what he says are three empirical facts:
> A better economic outlook and higher yields in the US have been typically followed by stronger growth, rising risk appetites, and capital inflows in emerging economies.
> A strong US dollar is not the cause of emerging market struggles. Quite the contrary: a strong dollar is result of an adjustment process that, historically, has fed their economic recovery.
> Emerging markets are a heterogeneous group of countries that over the years have built significantly larger reserves and a domestic debt market. Hence, the likelihood of observing widespread currency and banking crises has decreased.