How The Strength of the US dollar Might Impact Emerging Markets?

Even though, the U.S. dollar does not hold an official title of global currency, defacto it is. For more than 70 years, it has been the world’s number one reserve currency, and it still dominates the global market at a time.

Despite never-ending predictions that the dollar’s days as the world’s most traded currency are numbered, it has enjoyed a strong comeback in 2018.

The question is, will the U.S. Dollar rise further in 2019? The latest economic forecast from Goldman Sachs suggests that the American greenback is destined to give up last year gains and weaken in the coming year.

– What do the terms weak dollar and strong dollar mean?

– What’s behind the weakening American dollar?

– How will the weakening of the U.S. Dollar impact emerging markets?

Keep reading, as we will be answering all of these questions in the following article. 

What do the terms weak dollar and strong dollar mean?

Most of the currencies float in value relative to one another, depending on many factors, including how strong the economy of the country is. Because the U.S. dollar is the most traded currency in the world, the value of other money is often denoted against it. The U.S. greenback is like a standard by which other currencies are measured. But what do the terms weak dollar and strong dollar really mean?

The dollar’s strength is the relative value of American money versus other currencies. In the simplest terms, the stronger the dollar is, the more of the other currency you can buy with it. It also means that once you change the US dollars into Brazilian real, Chinese Yuan or British pounds, you can buy a lot more of a foreign country’s goods with a stronger U.S. currency.

On the other hand, the stronger U.S. dollar could be bad news for the American companies that sell services and goods abroad. A strong U.S. dollar makes American exports more expensive for those with a relatively weaker currency, so the U.S. goods become more costly for them.

In 2018 American greenback climbed towards one of its highest levels. Will it weaken through the coming year? It depends on numerous complex factors like the U.S. Dollar supply versus demand, trade, investment, inflation changes, economic growth and even the way the world views the country.

What’s behind the weakening American dollar?

Because the U.S. dollar makes up for 64% of global foreign exchange reserves, it has a unique relationship with world’s economic growth. In times, when the global economy flatten, the value of U.S. money rises; and the U.S. dollar weakens when the global economy picks up.

In their latest economic forecasts, Goldman Sachs stated that they predict economic growth of the U.S. to slow down a bit in 2019 to be more in line with the world average growth. The forecasted growth of U.S. economy is projected to go down from 3.2% to around 2% in the year 2019, while the rest of the world’s economy will steadily grow at a pace of around 2%. This means that overvalued U.S. dollar will have to undergo a necessary correction as well.

The fact that U.S. economic growth slowed down a bit is one of the reasons why central banks all over the world have started diversifying their reserve allocations from the greenback in favor of different currencies. 

Some experts are even convinced that it’s not so much that the U.S. dollar that is weakening, but other currencies like euro and yen are getting stronger against it. 

This minor U.S. economic slowdown will drive a lot of investments out of American asset markets. This, combined with Donald Trump’s  U.S. protectionist rhetoric would inevitably affect the value of the U.S. dollar.

Donald Trump’s desire to keep the U.S. dollar weak comes as no surprise. A weaker dollar would help the president to achieve some of his major economy goals, including revitalizing the U.S. manufacturing industry, creating jobs for U.S. workers, making American-made products more affordable to foreign buyers and limiting imports.

However, would weak U.S. dollar policy, including the President Donald Trump’s 2018 tax cuts and reforms really help the U.S. economy, or would they stop the development in its tracks? It’s hard to tell yet, but one thing is sure: the U.S. dollar strength and emerging market development are interdependent.  

How the strength of the US dollar might impact emerging markets?

Despite the predictions, that US dollar will soon have to share its title of the world’s most important currency with euro and yuan, for now, greenback remains the number one global currency. Most international trade is still conducted in U.S. dollars, so its value directly affects developing markets.

As a general rule of thumb, a weak dollar means strong commodities for emerging markets. Experts predict that commodity exporters like Brazil, Chile, and Venezuela will bloom under a weaker U.S. dollar. Because the global market prices commodities in American dollars, a weaker greenback would make them more affordable and more demandable for international buyers. With more demand, the price for those commodities would eventually increase, which would translate into economic growth, increased GDP, more jobs, more business opportunities and often – into a better standard of living.

Emerging market companies that sell their services internationally would also benefit from a weaker dollar. In simple terms, a weaker dollar is a positive for multinational companies, because it makes their services more affordable for foreign markets.

Weakening dollar is also a good thing for borrowers. When the U.S. dollar rises in value, it is more difficult for developing countries who have their debt denominated in dollars to pay it back.  So when the American dollar depreciates, these debts become cheaper and, as a result, easier to service.

With a weakened U.S. currency, foreigners can also borrow more in dollars. Some experts argue that this might not be the smartest strategy in the long term, however it helped many emerging markets like South Africa to finance different growth initiatives.

Investment strategy specialist, Andriy Zhovtanetskyi, MBA, Toronto, Canada, also agrees that rising U.S. dollar would batter emerging economies with U.S. dollar-denominated debt:  “The hike of benchmark interest rate in the U.S. makes it more difficult for the governments and corporations to serve their dollar denominated debts”.

Another advantageous outcome of the depreciated dollar for emerging economies is higher foreign investments. Andriy Zhovtanetskyi believes that weakening dollar would bring significant direct investments into emerging markets like LatAm countries: “A strong dollar accelerates capital outflows from emerging markets because foreign investors expect to gain higher returns per certain amount of risk. When the dollar is getting weaker, investors are encouraged to buy higher-yielding assets denominated in currencies other than the American dollar”.

The Bottom Line

Since the dollar considered to be a global reserve currency, its expected 2019 depreciation would have a significant impact on both American and foreign markets. Emerging markets like Chile, Brazil, Colombia, Peru, Mexico would particularly benefit from dollar’s depreciation. 

Weaker U.S. dollar should help developing countries, including LatAm region states, to make their commodities and services more desirable on global markets. The falling dollar also means that a lot more investors would be looking out of American asset markets. Maybe you should to?