Emerging markets feel dollar pinch

A perky dollar hurt emerging market assets yesterday with stocks edging lower and many currencies weakening, but Turkey’s lira rallied to a oneweek high on expectations of another interest rate hike next week.

The dollar chalked up solid gains for a second straight day and hit its highest level in nearly three weeks after Federal Reserve Chairman Jerome Powell gave an upbeat assessment on the US economy and played down the impact of global trade risks on the outlook for interest rate hikes.

The stronger dollar and prospect of higher borrowing costs cast a shadow over emerging markets with MSCI’s emerging market index slipping 0.2%.

“It is having an impact since the market is thinking maybe rates will increase, which is not new, but maybe a bit quicker,” said Sebastien Barbe, head of emerging markets research and strategy at Credit Agricole. The broader benchmark was dragged lower by losses in Asia, where indexes in China mainland and Hong Kong lost 0.3% while export behemoth South Korea slipped 0.4%. China stocks have also suffered in recent days and weeks as concerns over slowing growth in the world’s second largest economy and an escalating trade conflict between Beijing and Washington.

“For me the trade war is definitely the big concern for the next few months,” said Barbe, adding a trade conflict could have a twofold impact on emerging markets in disrupting supply and trade links and also a correction of global stock markets which would spread to emerging equities and trigger capital outflows.

“The next few months are risky for emerging markets mostly due to protectionist fears, because the other risk, the tightening of monetary policy in the US, is mostly priced in.” Currencies also painted a glum picture. Russia’s rouble chalked up some of the biggest losses against the dollar, weakening 0.6% with oil prices slipping more than 1% adding to the pressure.

South Africa’s rand and Mexico’s peso weakened 0.3%, while China’s yuan also edged lower. However, Turkey’s lira proved the exception to the rule, strengthening 0.5% as markets were increasingly expecting that the country’s central bank would be forced to hike interest rates once again at its policy meeting next week.