Capital IdeasTM
Investment insights from Capital Group
Emerging Markets
Natalya Zeman
A weakening US dollar has historically created a positive backdrop for emerging market equities, with the two asset classes inversely correlated, and a sharp decline in the dollar over recent months has led many to claim its decade-long bull run may be coming to an end.
Inverse correlation between EM equities and USD
Six-month moving average: EM equities relative to developed market equities (LHS) vs. US Dollar Index (RHS)
.png "Inverse correlation between em equities and usd")
Data to 30 April 2023. Source: Capital Group
MSCI EM: MSCI Emerging Markets Index. MSCI World: MSCI World Index
If we look back at history, a strong US dollar has been associated with increased debt risk for emerging markets, slowing global growth and trade troubles. A strong dollar is also associated with ‘flight to safety’ tendencies as investors have traditionally flocked to the currency during periods of uncertainty due to its liquidity, reserve status, track record of economic and political stability, transparency, and rule of law.
As we look ahead, however, growing evidence suggests cyclical US dollar weakening may be on the horizon. Structurally, meanwhile, after 15 years of US economic and US dollar leadership, the relative attractiveness of the US versus emerging markets could be narrowing.
Against this backdrop, Investment Director Natalya Zeman looks at whether the right drivers are in place to spark a fresh run for emerging market equities.
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