Fund managers remain optimistic on the outlook for emerging markets despite the sharp rise in the US dollar, pointing to structural reforms in the region, continued strong global growth and greater local currency issuance.
In the week ending 4 May, emerging markets sold off following a rally in the dollar, with the Dollar index (which tracks the greenback against the euro, yen, sterling and six other currencies) hitting its highest level since December 2017 at 93.280 last Tuesday.
In the same week, the MSCI Emerging Markets index slumped 1.7%, while the Bloomberg Barclays Global EM Currency Government Debt index fell 0.8%, marking its fourth week of losses.
Elsewhere, the JP Morgan Emerging Markets Currency index dropped 1.7% to a one-year low at 66.954, its worst week since President Donald Trump was elected in November 2016, while $1.2bn in emerging market debt (EMD) was withdrawn from global funds between 25 April and 2 May, according to Bloomberg.
A rising dollar tends to have a negative effect on emerging markets due to a fall in trade across the region, the increased difficulty for countries paying back dollar-denominated debt and investors fleeing emerging market debt.
The dollar rally since mid-April has been driven by improving US growth and market expectations for more interest rate rises from the Federal Reserve, which hiked rates in March for the first time this year.
But subsequent volatility in the region caused Fed chairman Jerome Powell to reassure an audience in Zurich last Tuesday that monetary policy tightening by central banks was a manageable risk in developing markets.
Amanda O'Toole, co-manager of the AXA Framlington Global Thematics strategy, added the structural changes that have taken place in a number of emerging market countries mean the region as a whole is more insulated than in previous cycles.
She gave the example of India, which has seen significant progress in terms of internal restructuring under Prime Minister Narendra Modi, such as demonetisation, making it more resistant to sharp spikes in the dollar.
"If you look at the emerging market structure, historically the strengthening US dollar would have been painful, but there have been a lot of structural reforms within many countries," she said.
"This means we are less concerned about emerging markets than we would have been in the past.
"Markets such as Indonesia and Turkey are exposed, but they are much smaller as a proportion of the emerging market index so the impact should be less significant than it might have been in previous cycles.
"There are some countries that have made significant improvements to their ability to operate in this environment."
Wei Li, head of iShares EMEA investment strategy at BlackRock, said the macro case for the region was strong as a result of positive economic reform in countries such as China and improving corporate fundamentals.
Furthermore, she argued the main driver behind dollar strength - strong US growth - was not necessarily as negative for emerging market assets as the taper tantrum in 2013 as it meant stronger global growth.
"We see above-trend growth in developed markets which, at this point in the cycle, has a greater positive impact on emerging market economies, and increasing capex spend feed-through."
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