This is a chapter from the Emerging markets: An evolving landscape paper. To read all chapters in this paper, click here.
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As the landscape within emerging markets (EM) continues to shift and adapt, we believe the possibility of EM’s positive returns appears promising. In this chapter, we highlight how the changing tides in US policy and macroeconomics may favourably impact the EM asset class.
- Core inflation has stabilised
- Policymakers have signalled that rates have peaked
- US dollar is expected to weaken following rate cuts
With the Federal Reserve fund target rate expected to fall over the next few years, we believe this will add to US dollar headwinds. Macroeconomic factors such as a surging federal debt levels and increasing fiscal deficits may add to US dollar weakness as well as the potential shift of allocation from US dollar assets to non-US dollar assets. Besides the overweight that allocators have to US equities, there are many other asset classes (such as Private Equity and Private Credit) which are largely dominated by US-domiciled firms and as such are predominantly US dollar-driven.
However, EM equities can also benefit from a strong US dollar environment. For export-dominated EM economies such as China, Korea, and Taiwan, a weak local currency is a net beneficiary to export economies (makes exports more competitively positioned). From a company perspective, there is also positive operational gearing. For example, for semiconductor companies in Korea and Taiwan, they often have local operations with local currencies and sell products to US clients in US dollars. This means that even in a weakening local currency environment, these companies and countries could see positive terms of trade and positive operating levers.
We think that a weakening dollar can support EM performance, given the widely-held belief that they are negatively correlated by market participants. We anticipate that this will remove a further headwind which EM economies have faced in recent years.
WHAT ARE THE RISKS?
All investments involve risks, including possible loss of principal. Please note that an investor cannot invest directly in an index. Unmanaged index returns do not reflect any fees, expenses or sales charges. Past performance is no guarantee of future results.
Equity securities are subject to price fluctuation and possible loss of principal.
International investments are subject to special risks including currency fluctuations, social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets.
Commodities and currencies contain heightened risk that include market, political, regulatory, and natural conditions and may not be suitable for all investors.
The government’s participation in the economy is still high and, therefore, investments in China will be subject to larger regulatory risk levels compared to many other countries.
There are special risks associated with investments in China, Hong Kong and Taiwan, including less liquidity, expropriation, confiscatory taxation, international trade tensions, nationalization, and exchange control regulations and rapid inflation, all of which can negatively impact the fund. Investments in Taiwan could be adversely affected by its political and economic relationship with China.
US Treasuries are direct debt obligations issued and backed by the “full faith and credit” of the US government. The US government guarantees the principal and interest payments on US Treasuries when the securities are held to maturity. Unlike US Treasuries, debt securities issued by the federal agencies and instrumentalities and related investments may or may not be backed by the full faith and credit of the US government. Even when the US government guarantees principal and interest payments on securities, this guarantee does not apply to losses resulting from declines in the market value of these securities.