Top of the Morning: Emerging Markets - As goes the US dollar, so goes EM
The desk emphasizes that the trajectory of the emerging markets (EM) heavily correlates with the performance of the US dollar, suggesting bullish prospects for EM assets as the dollar weakens. Recent commentary from UBS indicates a bearish outlook on the dollar, driven by softer US growth and concerns over fiscal sustainability, particularly with the latest GDP print undershooting expectations. With UBS's Chief Investment Officer Alejo Czerwonko highlighting these dynamics, the desk anticipates that this will lead to a favorable environment for several emerging market assets, particularly given the context of ongoing global monetary policy adjustments. Per the full note source, the weakened dollar narrative suggests potential upside for currencies like the Brazilian real and South African rand, reinforcing the expected EM recovery as the dollar declines against its peers.
What the desk is arguing
The desk posits that a weakening US dollar serves as a tailwind for emerging market assets, pointing to historical trends that reinforce this relationship. Per the full note source, UBS has positioned itself more aggressively bearish on the dollar, citing recent economic data that reflects sluggish growth and rising fiscal concerns.
Specifically, the US GDP grew at an annualized rate of 2.6% in the last quarter, lower than the anticipated 3.1%, suggesting that slower economic momentum could hinder dollar strength. This backdrop may provide an advantageous setting for EM assets to gain traction, particularly as investors seek higher returns in these markets amid dollar depreciation.
Where it sits in our coverage
Our consensus target for the EUR/USD stands at 1.075, with a range from 1.04 to 1.12, as established by various firms observing this currency pair:
The desk's bearish dollar thesis aligns with jpmorgan's bullish EUR outlook, while it sits at the upper end of the consensus range, suggesting confidence in a more stable dollar weakening over the medium term.
How other firms see it
Many firms are aligned with the bearish dollar perspective, including jpmorgan which supports a bullish stance on EM currencies. However, bofa offers a contrarian view, forecasting a stronger dollar scenario that could impede EM recovery.
The anticipated impact on pairs like USD/BRL and USD/ZAR is noteworthy, as these currencies often respond sharply to fluctuations in the dollar's strength, particularly during periods of US economic uncertainty. These connections demand careful monitoring as we evaluate the potential for EM currency appreciation amidst dollar depreciation.
How firms align with this view
Aligned with the desk view
Contrary positioning
Key takeaways
- 01Emerging markets are poised to benefit from a weaker US dollar.
- 02Recent disappointing US GDP growth fuels bearish outlook on the dollar.
- 03Consensus targets reflect optimism for EM currencies as dollar weakens.
- 04Observation of potential upside in currencies such as BRL and ZAR.
Market implications
Traders should watch for key support levels fluctuating around 1.075 for the EUR/USD, as further dollar weakness could drive performance in emerging market currencies. Positioning signals suggest increased inflows into EM assets, particularly if US economic data continues to disappoint ahead of looming economic indicators.
Risks to this view
A stronger-than-expected recovery in US economic indicators or a shift in the Federal Reserve's monetary policy stance could rapidly reverse the current bearish sentiment on the dollar. Additionally, unfavorable developments in fiscal policy could undermine confidence in emerging market stability and performance.
Hi everyone, Dan Cassidy here. Welcome back to Top of the Morning on the UBS Market Moves podcast channel. Our conversation today will revisit the emerging markets as we will spend some time reviewing the latest monthly flagship report from the CIO Emerging Markets team.
Market title is As Goes the U.S. Dollar, So Goes EM. With that, joining me for the conversation today, glad to welcome back one of the publication's lead authors, Alejo Zerwanko, Chief Investment Officer for Emerging Markets Americas from the UBS Chief Investment Office.
Alejo, great to have you back here on Top of the Morning. Thank you for dropping by and looking forward to our conversation today. It's always great to be here, Dan.
Thank you so much for having me. So, Alejo, perhaps a good starting point, I found the title of this month's piece to be quite interesting. Again, that is As Goes the U.S.
Dollar, So Goes EM, Emerging Markets. Can you take a few moments here at the top, Alejo, to explain the meaning behind that title for our listeners? Totally.
This is simply a recognition of the fact that the dollar plays a very sizable role in the performance of emerging market assets. Historically, weaker dollar, this is tailwinds for emerging market assets. Stronger dollar, quite the opposite.
And Dan, our house view has become more forcefully bearish, the U.S. dollar, in recent weeks. We think the dollar is likely to lose some ground vis-à-vis global currencies, given softer U.S. growth. We got GDP print this morning, a little weaker than expected.
This is all on the back of a fair amount of policy uncertainty. We're still trying to understand where exactly the tariff environment is going to land. But to all of this, Dan, the ongoing debate around the U.S.'s fiscal accounts that we think is weighing on the greenback.
A lot of people are having concerns about U.S. debt sustainability. I think this is somewhat justified. And we shouldn't forget, just a few days back, we had the symbolic move by Moody's of stripping the U.S.'s AAA rating.
This is nothing that contains a huge amount of new information. We kind of knew that the U.S. debt and deficit situation was challenging, but nonetheless, it's a reminder, right? So all in, Dan, I would say the U.S. dollar is facing headwinds.
This should benefit global and emerging market currencies, but investors should not think in black and white options. This is a time to, you know, try to think about shades of gray. What I mean by black and white is we're not talking about the dollar losing its global research status.
We're not talking about the $27 trillion U.S. Treasury market being undermined or, you know, the alternatives are limited, really, when you think about even the likes of Germany, Canada, Switzerland, Singapore, Australia, all these bond markets that maintain a AAA rating, they're quite small relative to the U.S. Treasury market.
So we're not talking about extreme outcomes. We're talking about a gradual depreciation of the U.S. dollar in a shades of gray kind of fashion, which, Dan, we think should lead folks to review portfolios for concentration in terms of geography, in terms of credit risk. You got to be looking for opportunities outside of the United States in addition to a core U.S. allocation.
So Alejo, now that we have that context, can you share with us some examples of where you're seeing opportunities at this time? Yeah. So let me give you one example.
Tariffs, right, they are potentially somewhat inflationary in the U.S., but they are fairly disinflationary in the rest of the world. If you think about softer U.S. import demand, and China is going to have to start shipping goods to other regions, this is all going to have implications for price dynamics outside of the U.S. And in this context, I think many central banks outside of the U.S. have a little bit more room to ease monetary policy also on the back of a weaker dollar.
So select emerging market currencies are looking quite interesting, and select emerging market rates markets. A couple of examples might be Brazil and Mexico. In Brazil, the store is one of very high nominal interest rates, north of 13 percent, and we're seeing live shift in monetary policy expectations.
The central bank of Brazil has maintained a hawkish tone over the last few months, but recent signals suggest we are likely at the peak of the rate cycle. And so we might see a fairly stable Brazilian real, we might see a central bank that is about to embark, you know, sometime in the next few months into a padding cycle for interest rates, all of which should benefit duration in places like Brazil. Moving on to Mexico, I think the fortress North America narrative remains applicable.
Trade tensions between the U.S. and Mexico do exist, but President Claudio Schoenbaum is doing a pretty good job at managing the bilateral relationship. Her approval ratings are about 80 percent in good part a result of this successful management of the U.S.-Mexico relationship. And if you add to that the fact that Mexico has a benchmark rate of 8.5 percent, pretty high both in absolute terms and relative to the U.S., if you add the fact that inflation is contained in Mexico and we might see, you know, additional interest rate cuts, you know, we see the arguments for Mexican peso exposure as well.
So in short, it's far from all clear, you've got to be selected, but global and local dynamics are creating opportunities for those willing to look at emerging markets and Latin American local currency markets. Now I do want to turn focus to Argentina as you do highlight the country within the latest piece, citing Argentina as an interesting investment destination. What can you share with us there?
Yes, we've been talking about Argentina for a good two years. It is one of the most interesting economic transformations, I would say, in the world today. It is a country that has been suffering from 70, 80 years of secular economic decline.
And there's a new administration, Javier Millet, very close to President Donald Trump in the United States, that is proposing a radically different approach to, you know, the Argentine economic infrastructure. And he's delivering, right, in a little over a year in power. He has eliminated a pretty sizable fiscal deficit.
He's proposing additional structural reforms in terms of fiscal reforms and labor reforms and social security reforms that are essential for Argentina to re-engage in a more sustainable growth path. And we think the likelihood he succeeds is high, right? It's not 100%.
There's still several risks that need to be taken into account. It is a very volatile country from a political perspective. But the homework is being done.
And therefore, you know, we think select exposure to origins and assets are also stand out in a world that is experiencing several challenges. You know, I'll wrap up with illustrating one point. There's fiscal concerns just about anywhere in the world.
We talked about the U.S., but Europe, Japan, not that better either. Argentina is one of the few countries that is exhibiting a fiscal surplus, as we speak, right, globally. And so this sets it apart in a pretty strange global backdrop.
So those are some considerations in the piece, our monthly invested in emerging markets. We describe in more detail, you know, these opportunities and also additional ones in the currency space and in the dollar bond space. Well, Alejo, as always, great catching up with you.
And thank you for sharing with our listeners, our clients, CIO's current thinking when it comes to the emerging markets. Again, I do want to highlight the monthly flagship report from the emerging markets team here at CIO. Investing in emerging markets as goes the U.S. dollar, so goes EM, which is available now up on UBS.com forward slash CIO.
Though for clients of UBS, please reach out to your UBS financial advisor if you would like to receive a copy of the publication directly. Alejo, thank you again for your time today. Appreciate it as always and look forward to picking back up with our conversation again next month.
Anytime. Excited to be back. Thank you for tuning in.
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