The world economy is slowing. In past recessions, fast-growing emerging markets have helped bail out the global economy. But there’s one thing standing in the way of history repeating itself this time: the strong US dollar.
As global growth slows and the United States’ economy shows signs of weakness, investors are looking for places where their money will grow.
Emerging markets, such as South Korea, Brazil or India, are riskier to invest in but often grow faster than developed nations like Germany or the US. They also tend to be export-driven and often tied to commodity price moves.
In the recession following the financial crisis, China provided a boost for the global economy, growing nearly 9% on the back of strong domestic spending. “Without China, global growth would have been negative in 2009,” said Bank of America strategist David Hauner in a note.
But circumstances have changed in the past decade. China probably won’t be the knight in shining armor this time. The country’s economy is slowing too and it is more highly leveraged than it was a decade ago.
It will be hard for other emerging markets to step in and help avoid a global recession as long as the US dollar remains strong: Emerging economies tend to borrow in dollars. These countries are uniquely vulnerable to a strong greenback, which can make their debts more expensive.
A weaker US currency could alleviate that strain and allow emerging markets to grow faster, perhaps keeping the world out of a global growth recession. The Federal Reserve is gradually lowering rates, which could help to weaken the greenback. But it hasn’t exactly been moving with any urgency so far — certainly not as quickly as US President Donald Trump would like.
“Emerging markets can help to ‘save the world’ in this downturn, but this requires a weaker US dollar and thus a much more dovish Fed,” said Hauner.
Developed countries like the United States and its European peers are also increasingly worried that their ultra-low interest rate policies aren’t actually stimulating any growth. Japan has been the prime example of that, and investors are now talking about the Japanification of Europe. The US economy is expanding at a faster pace than its rivals, but growth is still slowing.
The Federal Reserve is meeting next week, and the chances of another quarter percentage point interest rate cut are over 90%, according to the CME FedWatch Tool. Whether this will be enough to knock the dollar remains to be seen. Currencies commonly weaken during periods of looser monetary policy.
Complaints about the strength of America’s currency have mounted this year. From Trump to Democratic presidential candidate Elizabeth Warren, critics say the strong buck makes US goods less competitive on the global market.
The often-cited ICE US Dollar Index, which measures the currency against six rivals, is actually only up 1.6% this year. But a look at specific emerging currencies shows a different picture.
The dollar is up 1.9% against India’s rupee, 4.1% against Brazil’s real, and 5.5% against the South Korean won since the start of the year — to a large extent because of the trade war.
Making matters worse, emerging economies borrow mostly in dollars, while their biggest customers mostly pay in euros, Hauner said. So these countries are also uniquely exposed to the euro-dollar exchange rate. This year, the shared European currency has fallen 3.2% against the greenback.