Developing countries have been on a borrowing binge this year with nine months of bumper investment inflows and record bond sales, but a sharp U.S. dollar bounce into year-end could end the party early.
Signs of an upswing in the dollar’s fortunes made the last week of September poor — equities fell 2%, bond yields rose about 10 basis points and currencies weakened on average by over 1%, their worst week since last November.
Cast a chill
While emerging markets are still among the year’s best performing assets, the moves last week cast a chill on the sector. They closely emulated those in late-2016 when Donald Trump’s U.S. election win and stimulus plans briefly boosted the dollar. Last week’s swings were driven by expectations of a December U.S. rate hike. But possibly, a bigger threat is the revival, after many months, of the so-called Trumpflation bet — Mr. Trump’s plans for stimulus through tax cuts.
The measures could be immensely dollar-supportive, especially if they induce U.S. firms to repatriate cash held overseas. Estimates of such holdings are reckoned to be well over $1 trillion.
That could see the dollar repeating the 12% surge it witnessed in 2005, after a 2004 tax holiday lured home about $300 billion. That’s a formidable hurdle for emerging markets, which usually suffer when the dollar strengthens.
“The last time they did it (encouraged dollar repatriation), it had a huge impact on the dollar and this time the scale could be much larger,” said Abhishek Kumar, lead portfolio manager for emerging markets at State Street Global Advisors.
“We think we may see a moderation of inflows into emerging markets in the fourth quarter and going into 2018,” Hung Tran, MD of the Institute of International Finance (IIF) said, though he did not see flows reversing.
The IIF estimates total developing world debt at $56 trillion, up $3 trillion in the past year.