The effect of the rising dollar on emerging markets - devaluation, not revaluation

Outlook:

We get consumer spending this morning, forecast up a measly 0.1% in Septem-ber. Chicago PMI comes a little later and also the University of Michigan consumer sentiment index. Normally consumer spending would be top-tier but we say the glow from GDP will probably trump it. Aside from the inevitable corrective pullbacks, the dollar is on its way to a stronger performance overall based on relative real fundamentals (not flight-to-safety fear).

The next move is Mr. Draghi’s at the policy meeting next week. Will he affirm existing QE and promise more? If so, the euro should get weaker. But you never know—a confidence factor could provide more euro support than would be normal. The euro has proven itself able to weather storms that would fell a lesser currency.

But something else is brewing at the back of the stove—the effect of the rising dollar on emerging mar-kets and their currencies. This is a little different than the currency war debate we had a few years ago. This time it’s devaluation, not revaluation, and some countries will suffer disproportionately. The FT reports that the dollar is up against the won, ringgit and rupiah, “But the worst performing currencies were those of central and eastern European countries squeezed between low growth and inflation in the eurozone, and turmoil in the sanctions-hit Russian economy. The Polish zloty hit a 16-month low against the dollar, taking its losses over the past three months to almost 7 per cent. The Hungarian forint has fallen almost 5 per cent over the same period, while the Czech koruna is down more than 6 per cent.”

With risk rising in EM assets, will investors exit en masse? A lot depends on the reasonableness of the policy response in each case. Brazil already raised rates, for example. But the EM’s have a wild card—China. As long as the EM has something to exploit—minerals, oil, whatever—China is less attuned to immediate return and working for the long haul. We say it’s a Quixotic task, having had our heart bro-ken by Africa, but never mind. Wise global investors will be winnowing the wheat from the chaff in the EM’s and that will be interesting.

Buy dollars, forget corrections.