3 Ways the Greenback's Strength Could Hurt Emerging Markets
How the Stronger U.S. Dollar Hurts Emerging Markets
The U.S. dollar has risen in value against most major currencies throughout the first half of 2015. Between January and July, the Australian dollar, Canadian dollar, and euro have each fallen about 10% relative to the U.S. dollar. The prospects of higher interest rates have sent the U.S. dollar’s value even higher in recent months, with Federal Reserve Chairwoman Janet Yellen hinting that rates could rise before 2016, if the economy continued to improve.
Many U.S. businesses aren’t happy with the rising U.S. dollar, since their products and services are not as competitively priced, but emerging markets could have the most to lose.
Dollar Denominated Debt
Many emerging markets issue dollar denominated debt as a result of trade gaps and record low interest rates in the United States. According to the Bank of International Settlements, dollar-denominated debt from the developing world more than doubled between 2009 and 2014 from $2 trillion to $4.5 trillion. These debts include those from corporate giants like Russia’s Gazprom and Brazil’s Petrobras in the billions of dollars.
The problems with these growing dollar debts begin to surface when currency mismatches occur. For instance, approximately a quarter of all Chinese corporate debt is dollar-denominated, but less than 10% of its corporate earnings coming in dollars. A rising U.S. dollar means that the debt becomes more expensive to service – in some ways, it’s like they have to pay back creditors a full dollar when they’re only earning $0.90 on the dollar.
Sovereign Debt Yields
The rising U.S. dollar means that Treasury yields may finally start to come off of their record lows sustained since the 2008 economic crisis. In the past, investors were forced to buy emerging market corporate and government bonds in search of yield amid record low interest rates in developed countries.
The market for emerging market bonds more than doubled between 2009 and 2015 to $1.5 trillion – overtaking the U.S. high yield debt market.
These dynamics create a problem for emerging market governments that are running deficits or corporations operating on shaky foundations. By making it more expensive to raise new debt and refinance existing debt, by increasing the supply side of the equation, these companies and governments could find themselves in a dangerous self-enforcing downward spiral where credit risk becomes greater and debt service expenses rise.
Impact on Commodities
Commodities have fallen sharply during the first half of 2015, due to both increasing geopolitical tensions and the rising U.S. dollar. On the political front, investors remain concerned over Greece’s precarious spot in the Eurozone and China’s troubled stock markets. These issues are compounded by the rising U.S. dollar, which has an obvious inverse effect on commodity prices, since most commodities are priced in U.S. dollars.
Lower commodity prices have also led to lower profit for many foreign corporations, which have outstanding debt denominated in U.S. dollars, thus making it more difficult to pay. Many of the larger international companies – including Gazprom and Petrobras – could be especially affected by these dynamics given their large amounts of dollar-denominated debt.
Key Takeaway Points
- The U.S. dollar has been rising in value relative to many other major currencies, including many emerging market currencies.
- Repaying dollar-denominated debt becomes increasingly difficult as the U.S. dollar rises relative to the currency that foreign firms are earning.
- Sovereign debt and emerging market bonds may also be impacted by the rising U.S. dollar, since Treasury yields are likely to increase as a result.
- The rising U.S. dollar has had a bearish impact on commodity prices – denominated in U.S. dollars – which has compounded these problems.