Stronger dollar prolongs recovery for emerging markets currencies 

• Nigeria’s Naira in pit for much longer  

PHILLIP ISAKPA IN LONDON, UK

Unfolding economic dynamics in the United States that have primed the dollar to be stronger will ricochet in many emerging markets (EMs) potentially lengthening the recovery timeline of their currencies, a global market analyst and asset management firm, deVere Group has projected.

Pressure is expected to mount on EM currencies on the back of the leveraged position of these countries who have international loan exposures that they have to repay in dollars.

“Many emerging market countries’ governments and corporations borrow in US dollars, when the dollar strengthens, the cost of servicing this debt increases for these borrowers because they need to convert more of their local currency into dollars to repay their obligations,” explains Nigel Green, chief executive officer of deVere Group in an analyst note to Business a.m. over the weekend.

For the Nigerian Naira, this would be bad news and a clear signal that its own recovery would be much longer. The domestic currency has been tanking much faster since June when the government carried out a raft of International Monetary Fund and World Bank favoured reforms. The government announced the removal of petroleum subsidy and the floating of its currency, exposing it to an onslaught in the market that has seen it reaching an all-time low of N1,851 to the dollar.

But the stage for the emerging markets prediction has been set in the US economy where data showed that the world’s largest economy’s producer price index (PPI) rose higher than was predicted for the month of February; and it came only days after another statistics revealed an unexpected rise in consumer price index (CPI), which then slashed chances of imminent cuts in interest rates by the US central bank, the Federal Reserve.

The possible recovery prognosis for EM currencies, according to deVere Group analysis, is at least the third quarter of this year. “Emerging market currencies are going to be under pressure until at least the third quarter of 2024,” the analyst note warned.

“The PPI in the US strengthens our position that the Fed is almost now, certainly not going to cut rates this month; and we now believe it could delay cutting rates until the third quarter of the year,” said the deVere chief executive in a note. 

He stated that this would continue to strengthen the dollar and impact emerging market currencies, where many of their governments and corporations borrow internationally in US dollars.

Explaining the scenario of what typically happens, deVere noted that such situations can strain government budgets and corporate balance sheets; noting, for example, that if the dollar strengthens against the Brazilian real, Brazilian companies with dollar-denominated debt will face higher repayment costs.

“A strong dollar can also trigger capital outflows from emerging markets as investors seek higher returns in U.S. assets,” said the note. 

Explaining further, Nigel Green said: “This typically leads to depreciation of emerging market currencies as demand for them decreases. For example, if investors believe that the U.S. economy is performing better than emerging market economies, they may move their investments out of emerging market assets, causing the local currencies to weaken.” 

The analyst note cited a 2013 case known as “taper tantrum” as an example of what might happen because in that year when the Federal Reserve hinted at reducing its bond-buying programme, it led to capital outflows from emerging markets and currency depreciations.

It further noted that its position is based on the fact that emerging market countries rely on exports for economic growth, adding that when the dollar strengthens, emerging market currencies weaken in comparison, making their exports more expensive for foreign buyers triggering “a decrease in export volume or a loss of competitiveness in global markets.” 

Emerging markets will also need to brace up for other pressures, including inflation, as the deVere note explained that a  weaker local currency resulting from a strong dollar can also lead to inflationary pressures in emerging market countries. 

“This is because imports become more expensive, which can drive up the prices of imported goods and raw materials. For example, if the dollar strengthens against the South African rand, South Africa may experience higher prices for imported commodities, impacting overall inflation levels,” Green explained.

According to the analyst note by deVere, the last mile to reach the Federal Reserve’s two percent (2%) inflation target seems to be a slow one and, as such, deVere says it expects high-for longer rates.

deVere also stated that there is also a legitimate narrative that the Biden administration will push to maintain a strengthening of the dollar this year as the US holds presidential election in November.

This is based on the fact that a robust dollar enhances consumer purchasing power and bolsters investor confidence, pivotal factors for a thriving economy and by maintaining a strong dollar, the Biden administration would be aiming to showcase economic stability and competence, potentially bolstering voter sentiment.

“This all means a stronger dollar which is challenging for emerging market currencies, as a strong greenback can lead to economic instability, higher borrowing costs, reduced competitiveness, and inflationary pressures in these countries,” Green wrote.

​The US economic dynamics involving the CPI and PPI data have also provided analysts with information to warn global investors of what the market play would be. 

deVere Group warned that markets should prepare for volatility with investors likely to react against a potential delay in rate cuts from the Federal Reserve. 

deVere Group is one of the world’s largest independent financial advisory and asset management organisations, and this prediction is on the back of headline inflation in the US printing at 3.2 percent in January, higher than expected, with core CPI dropping to 3.8 percent, also higher than expected.

“The latest US CPI data reinforces our position that the Fed is almost certainly not going to cut rates this month; and indeed it could, we believe, delay cutting rates until the third quarter of the year.

“As the markets are seemingly already pricing-in a rate cut in the summer, should there be a push back against this expectation, as we now believe there will be, we’ll see increased volatility across financial markets.” said Nigel Green.

According to deVere analysts, the cautionary note also comes following the recent data from the Federal Reserve’s favoured metric for inflation – the core personal consumption expenditures (PCE) price index.

It noted that data derived from the PCE index indicates a noteworthy surge in prices in January from the previous month, indicating a departure from the trend before.

“The uptick in the core PCE index inevitably raises concerns about the potential repercussions of inflationary forces, hinting that the surge in prices might compel the US central bank to reassess the timing of interest rate reductions,” the deVere chief executive officer said.

He continues: “It seems that the markets are currently indulging in wishful thinking about a rate cut in June.

“Furthermore, we think that when a shift does occur, and rates are indeed lowered, there will likely be a pause in the subsequent meeting to assess how the policy adjustment is impacting the world’s largest economy.

“If officials observe that the rate cut contributes excessively to market enthusiasm and demand, exacerbating price pressures, we would then anticipate there to be an extended pause.”

According to the analyst note, while the Federal Reserve is becoming increasingly confident about the fall in inflation since its peak in 2022, the central bank remains resolute that the fight against inflation is not over and the trajectory back to its target of two percent (2%) might take longer than had previously been predicted.

“We expect rates will be higher for longer still – and when there is finally a rate cut, there will be a pause to follow it. 

“Markets will respond negatively to this predicted scenario, so investors should buckle up and position their portfolios accordingly,” Green advised.

Road back to Japanese stocks for global investors

In another development, Japan’s fall into recession is not seen as hindering another round of appetite by global investors as 2024 is predicted as the year they will “rediscover” and pile back into Japanese stocks.

deVere Group is making the bullish prediction following a recent jump in Nikkei 225, Japan’s benchmark stock index, when it soared to unprecedented heights and reaching 39,029, a significant leap that surpassed the previous record high set in 1989.

“The main driver of Japan’s stock market resurgence lies in the robust corporate earnings reported by major companies,” said deVere in an analyst note. 

It further observed that banking, electronics, and consumer stocks, in particular, have displayed stellar financial performances, instilling confidence in investors, noting that the corporate sector’s ability to weather economic challenges and deliver strong earnings signals resilience and adaptability. 

A wave of optimism is sweeping through Japan’s equities market, writes deVere, adding that the government’s commitment to implementing investor-friendly measures has played a crucial role in creating a favourable investment climate. 

Regulatory reforms aimed at streamlining procedures, reducing bureaucracy, and enhancing transparency are instilling confidence in foreign investors, said Nigel Green, deVere’s chief.

“The removal of barriers and the promotion of a business-friendly environment contribute to the positive sentiment, making Japanese stocks an increasingly appealing choice for those seeking long-term growth,” he added.

According to deVere, another significant factor contributing to the resurgence of interest in Japanese stocks is the depreciation of the yen against the dollar. 

“The yen has weakened by approximately 6% against the dollar this year, and indications suggest that it is on track to drop to 33-year lows last seen in the late 20th century. This weakening currency is a double-edged sword that benefits Japanese exporters and, consequently, the overall economy,” said the analyst. 

Accordingly, for global investors, a weaker yen enhances the competitiveness of Japanese products on the global stage, making investments in Japanese companies more attractive, deVere stated.

The note stated that Japan’s commitment to enhanced corporate governance is set to become a linchpin in attracting foreign investors, stressing that Tokyo’s proactive measures to improve transparency, accountability, and shareholder returns have created a business environment that instils confidence. 

“The appointment of independent directors, improvements in disclosure practices, and aligning executive compensation with company performance demonstrate a commitment to responsible and sustainable business practices,” Green said. 

He added that foreign investors, increasingly prioritising ethical and well-governed investments, are finding Japan’s corporate governance reforms ever-more appealing.

“The combination of robust corporate earnings, investor-friendly measures, a weaker yen, and a commitment to improved corporate governance creates a compelling narrative for those considering investments in Japan,” Green advised investors. 

“It seems that 2024 is set to be the year that global investors, recognising the unique and lucrative prospects offered by its resurgent stock market, rediscover and pile back into Japanese equities,” he stressed.