Much commentary on recent EM equity declines has focused on the role of U.S. dollar strength. This makes sense for at least a couple of reasons. From a fundamental standpoint, a stronger dollar increases the burden of servicing dollar-denominated debt for EM companies and sovereigns. From a statistical standpoint, EM equities have historically tended to underperform their developed-market counterparts during periods of U.S. dollar strength.
While this is all well and true, we think that the dollar-strength narrative may be somewhat overdone. For all the talk of dollar strength, the Fed’s trade-weighted dollar index is no stronger now than it was in January 2017. Indeed, dollar’s gains in 2018 merely recouped the dollar’s losses of 2017.
We think that it is useful to view recent EM difficulties in the context of the global credit cycle. As the global economic recovery becomes more extended, investors become increasingly focused on identifying credit problems that may derail the recovery. As a part of this process, analysts are naturally attentive to developments in emerging markets, just as they are to developments concerning other sub-investment-grade borrowers, including highly leveraged European and U.S. corporations. Tightening Fed policy and the strong U.S. dollar are crucial developments in this process, but the main storyline is the extended stage of the global credit cycle.