Over the last 10 years, the amount of corporate and sovereign emerging market (“EM”) debt denominated in USD has increased 270% to more than $2 trillion.1
The US Dollar Index of Other Important Trading Partners (OITP) measures the value of the US dollar relative to a trade-weighted basket of EM currencies. This index has been trending steadily higher for the last five years.
It is arguably no coincidence that shortly before the dollar began its upward trend in May 2013, the cumulative excess return of the S&P 500 against the MSCI EM Index turned positive. It has been widening ever since and has accelerated since the end of April 2018.
Worth noting is that this excess return is measured against the local currency version of the MSCI Index – the excess return is not a direct result of currency depreciation.
There may, however, be an indirect currency effect via the debt.
By virtue of the dollar moving higher against EM currencies, the cost of servicing this $2 trillion of bonds has increased. Since the end of April 2018, the US Dollar Index (OITP) has risen 7.4%. This increased cost puts pressure on EM issuers, making it increasingly more difficult for them to both service their existing debt, and by extension, tap into the credit markets that have fueled much of their growth in recent years.
Meanwhile, the S&P 500 has outperformed the MSCI EM Local Index by 14.5% over the same period, with much less volatility. To the extent the dollar continues to rise against EM currencies, EM stocks may be expected to exhibit increasingly higher volatility relative to US equities.
1As measured by the face value of the bonds in the ICE BofAML US Emerging Markets External Debt Sovereign & Corporate Plus Index.
Unless otherwise noted, data is sourced from Bloomberg.
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