[NEW YORK] Whether or not President Barack Obama expressed concern about the strength of the dollar in private conversations at the Group of Seven summit, emerging markets are suffering the brunt of its strength in a trend that shows little sign of reversing.
Rising bond yields in the US and Germany are making dollar- and euro-denominated assets more attractive to international investors. A measure of developing-nation currencies fell against both the greenback and Europe's common currency over the past two weeks for the first time since December.
"In a world of higher yields and increased volatility, we believe that there is plenty more downside in emerging markets," Calvin Tse and James Lord, strategists at Morgan Stanley, wrote in a June 4 research report. "The dynamic has clearly shifted" as currencies of developing nations break away from moving in tandem with the euro, they wrote.
While a three-year-long drop in their exchange rates has helped reduce trade deficits in some developing countries, further weakness may shake the confidence of foreign investors who hold more than 30 per cent of local-currency debt. Emerging- market stocks have fallen in each of the past 12 days in the longest losing streak since 1990.
Bloomberg's gauge of the most-traded developing nation currencies sank 2.4 per cent against the dollar in the two weeks through June 5, while it fell 3.3 per cent versus the euro.
Currencies of commodity exporters led the decline over the past month, with Russia's ruble and Colombia's peso falling more than 9 per cent against the dollar. Turkey's lira tumbled as much as 5.3 per cent on Monday to a record low of 2.8096 per dollar after voters denied the ruling AK Party a majority government for the first time since 2002.
Concern is rising that renewed currency weakness after two months of respite may hurt emerging economies. The selloffs combined with wider price swings may "put strains" on developing-nation companies that have borrowed "heavily" in foreign currencies, which could trigger or exacerbate capital outflows, Mitsuhiro Furusawa, deputy managing director at the International Monetary Fund said in a speech Monday.
A strong dollar poses a problem as volatility in financial markets increases, Mr Obama told fellow G-7 leaders, according to a French official with knowledge of the talks. Mr Obama later denied making such a comment.
So far, the currency declines have been benign in most of the developing countries. While the average 30 per cent drop in emerging-market currencies since early 2011 has failed to boost exports and growth, it helped cut imports and narrow current- account deficits in the economies of Turkey and India among others.
Except for in places such as Brazil, currency depreciation has showed few signs of boosting inflation because of lower commodity prices.
"The currency depreciation didn't have real economic implications so far," Michael Ganske, the head of emerging markets at Rogge Global Partners in London, said by phone. "From that perspective, it's nothing bad. It's not something that is really concerning."
The risk is that the recent global bond rout that wiped out about US$1.2 trillion in value may increase volatility in emerging markets. That makes high-yielding assets less attractive.
Emerging-market local-currency bonds have declined 5.8 per cent in dollar terms this year through last week, extending their drop since the end of 2012 to 19 per cent, according to data compiled by JPMorgan Chase & Co. While their yields are 5.12 per centage points higher than five-year U.S. Treasuries, the premium is only at the average level for the past five years.
As of April, overseas investors held an average 30.5 per cent of local-currency bonds in the 10 largest emerging markets, compared with the all-time high of 31.2 per cent in January, according to Credit Suisse Group AG. Malaysia has the highest foreign ownership with 47 per cent, followed by 39 per cent in Poland and 38.5 per cent in Indonesia.
Capital outflows have already started. Investors pulled US$577.7 million from US exchange-traded funds that invest in emerging markets last week, the first outflow in almost three months, according to data compiled by Bloomberg.
"When the going gets tough, you see people cut their positions," Simon Quijano-Evans, head of emerging-market research at Commerzbank in London, said by phone. The willingness to hold emerging-market assets "can be very fluid," he said.