(MENAFN- Khaleej Times) As we enter the second half of trading for 2018, the outlook for emerging markets does not look positive. While developing market stocks concluded on Friday (July 6) higher for the first time in five days, the first week of July overall saw emerging markets extend the longest losing streak seen since November 2016. This has been mirrored in emerging market currencies, where the Colombian peso now stands independently as the only tracked currency to have advanced against the dollar year to date. The Indian rupee recently slid to its lowest level on record against the US dollar.
It wouldn't be an understatement to suggest that these look like worrying signs for the developing markets. In truth, this has been the most intense and prolonged period of pressure for emerging markets since the aftermath of when Donald Trump shocked the world by winning the United States elections in November 2016.
Questions are also being asked as to whether President Trump could be the catalyst behind the woes for developing markets. This isn't necessarily the catalyst, although it is true that trade war tensions and headlines that are dominating the world over a potential trade war are not supporting investor sentiment towards developing economies.
A trade war between the United States and China would not be an idiosyncratic affair and has the potential to derail global economic momentum that has not looked this positive since the turn of the decade. It would also risk weighing on investor sentiment to the point where traders are heavily reluctant towards taking on risk. This means less attraction to the stock markets in general, which would then consequently limit investor attraction to emerging market assets. This includes both developing markets and their currencies.
One factor that has been a prime influence behind the woes for developing markets is the overwhelming dollar strength that has seen the greenback climb above five per cent over the past three months. The dollar is currently valued around its strongest level in a year, meaning that a multitude of different currencies across the globe are being pressured by the dollar. Both the consistent underlying strength of economic momentum in the United States and the continual outlook that the Federal Reserve will be raising interest rates higher have supported the greenback. Indications that economic growth away from the United States is at risk of dipping lower has only increased the divergence in economic/monetary outlook that had previously helped the dollar climb to its highest level since 2002.
The broad-based dollar rally has essentially led to a number of different currencies across the globe falling victim to US dollar strength. Both the euro and pound lost five per cent in the second quarter, while the Japanese yen also lost four per cent. These are similar losses to that have been mirrored in emerging market currencies, where the yuan has lost five per cent, similar to the Indian rupee.
The fears over emerging market weakness will naturally raise questions over whether central banks will intervene in the market to protect their respective currency. This could come in the form of direct intervention in the foreign exchange market or raising interest rates in an effort to attract investors back into their respective market. At these times, it is essential to remember that the broad-based dollar rally that has contributed to the market weakness and the increase in interest rates from both the Reserve Bank of India and Bank of Indonesia have not actually benefited their currencies. For as long as buying the dollar continues to be the trend of the forex market, there is very little emerging markets can do to prevent weakness. And for a turnaround in emerging market currency weakness to be encouraged, we need a reversal in dollar strength.
In the meantime, there has been one category of winners for the emerging markets that have overall suffered from the US dollar momentum. Those currencies that are pegged to the dollar, including the UAE dirham and Saudi riyal have each seen their own gain from those that have weakened against the US dollar in recent months.
The writer is global head of currency strategy and market research at FXTM. Views expressed are his own and do not reflect the newspaper's policy.
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