The Implications of a Stronger Dollar on Emerging Market Investments

January 22, 2016

In 2015, the emerging market equity index declined 14.9%. While there are a variety of explanations for this, one can not underestimate the impact of a stronger dollar. In fact, currency losses were responsible for more than 60% of the decline for U.S.-based investors. This week’s chart of the week examines the mechanics of how a stronger dollar can drive losses for emerging market investments.

Typically when U.S. interest rates rise, the dollar strengthens relative to foreign currencies. Investors oftentimes onshore investments during rising rate periods, and as a result, the country as a whole “exports” less dollars. The commodity price declines — especially oil — have been a major contributor to the rise in the U.S. dollar as the U.S. exports fewer dollars per unit. In our chart, we use the quantity of oil imported multiplied by its price as a proxy for the amount of dollars exported each month. During 2014, the United States imported an average of $26 billion a month in oil. During the first ten months of 2015, the U.S. imported an average of $14 billion a month, clearly a large drop and in conjunction with dollar strengthening and emerging market equity declines.

So why do emerging market investments fall? Emerging market economies often depend on dollar-denominated revenues to service debts as well as manage interest rates and exchange rates. If emerging market countries are receiving less dollars from the U.S., they face increased pressures from higher borrowing costs and lower dollar-denominated revenues. In addition, with less revenue, it is more difficult to promote internal growth via exchange rates or interest rate policies. Unfortunately, as U.S. interest rates are poised to rise further in 2016, emerging markets are likely to experience heightened volatility as a result.