How a Strong US Dollar Can Hurt Emerging Markets

Strong Dollar

The US Dollar has surged in 2014, increasing in value since the start of the year versus every other major currency. A strong US dollar has big implications for the global economy and affects almost every investment in your portfolio. Not all of these effects are the same, however, and the most substantial impact may be on investments in emerging markets.

The most straightforward effect from a stronger US dollar is a decline in the value of international holdings for US investors. This is simply math: when the values of the investments in foreign currencies are converted back to US dollars, they’re worth less than they previously had been.

For some foreign companies part of this decline may be offset because a stronger dollar means that their exports become more affordable. But overall these direct effects of a stronger dollar tend to hurt emerging market investments. Both emerging market stocks and local-currency emerging market bonds have returned about -5% so far this year.

A stronger dollar has other effects as well. It tends to be associated with lower prices for commodities such as oil (there are a number of reasons for this association, with both a stronger dollar contributing to a lower oil price and a lower oil price contributing to a stronger dollar). The oil price has indeed plunged this year, particularly hurting oil-producing countries such as Russia, Venezuela, and a number of countries in the Middle East. With declining oil revenues and a tanking currency, Russia appears to be on the verge of a financial crisis that could wreak havoc on its economy.

There could be additional emerging market victims if the US dollar continues to gain strength. Many emerging markets have debts denominated in dollars, and a stronger dollar makes these debts harder to repay. Given their external debts and their proximity (both geographically and economically) to Russia, a number of other Eastern European countries may be vulnerable.