How Crucial is a Weaker Dollar in Supporting an EM Rally?

December, 2019 – 2 min read
As concerns of a near-term recession seem to have dissipated, we think—in what may be somewhat of a contrarian call—riskier assets look well-positioned to potentially outperform in the year ahead.

This post is part of our 2020: The Road Ahead series⁠—read, watch or listen to the full conversation here.
 

Biggest Risk

Heading into 2020, one risk facing the Asian region is an escalation of the trade and technology tensions between the U.S. and China. While higher U.S. tariffs and technology sanctions would undoubtedly have a direct impact on Chinese exports, an even greater negative effect could arguably be that on Chinese corporates. If corporates were to further slow—or halt their capital expenditures altogether—it would pose a serious obstacle to the growth of the manufacturing and construction sectors. In an extreme case, it could even push China into a recession-this is not a base case but also not outside of the realm of possibility.  

Tensions between the U.S. and China will likely ebb and flow over the course of multiple years, and are unlikely to be resolved in the next year. However, given the importance of the U.S. presidential election in 2020—and the fact that both President Trump and President Xi are facing other political and economic pressures domestically—the two administrations have expressed a willingness to reach a solution. To that end, we believe the likelihood of these risks coming to fruition in 2020 is relatively low. And if our assumption holds true, it would be quite constructive for the Asian region’s corporate earnings and economic outlook, as well as its currencies and equity markets. 
 

Biggest Opportunity

As we look ahead to the next year, we think there will be attractive opportunities in emerging markets local debt as well as emerging equities. There are three key reasons for this. First, we believe that the U.S. dollar may weaken in 2020 as the differential between U.S. and emerging market economic growth and interest rates continues to narrow in favor of emerging markets. The Fed’s dovish policy and a potential reversal in the trend of investors “hiding” in safe haven currencies could accentuate U.S. dollar weakness. 

Second, we believe there is a possibility we will see a recovery in the economic growth of some Asian countries in the coming six to 12 months—thanks to the implementation of an easier monetary policy, as well as greater government spending in China, India, Korea and some ASEAN nations. The third reason is that valuations of Asian and EM financial assets appear relatively inexpensive, as they’ve been significantly devalued as a result of the many macro uncertainties at play. If some of these headwinds start to clear, we think the valuations of emerging market assets could be partially restored, which could lead to better overall returns.
 

Bold Prediction

One bold prediction for 2020 is that we could see a bear market in government bonds and other defensive assets, and a bull market in growth assets like equities, high yield bonds and cyclical stocks. Concerns over a coming recession have been at the forefront over the last year, with the U.S. economy moving through the late stages of an elongated credit cycle and the inversion of the yield curve in mid-2019. More recently, however, some of these trends have reversed or moderated. As a result, concerns of a near-term recession seem to have dissipated. In this type of environment, while possibly somewhat of a contrarian call, we think riskier assets look well-positioned to potentially outperform in the year ahead.
 

IS THE RISK-OFF TRADE SET TO REVERSE?
U.S. FINANCIAL ACCOUNT YTD TRANSACTIONS BY ASSET

Sources: Federal Reserve Board; Haver. As of June 30, 2019.

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