How the ECB’s Latest Move Impacted Emerging Markets
The European Central Bank (ECB) unveiled its latest monetary policy, triggering a sharp euro decline that spells trouble for emerging markets worldwide.
The link between the ECB’s recent dovish policy announcement and emerging markets (EM) may not be immediately obvious, yet the impact on EM currencies was profound. If emerging market governments fail to stabilize their currencies, this shift could also ripple into North American stock markets. In our recent Daily Market Commentary webcast, our analyst broke down the reasons behind this dynamic and its potential effects on U.S. equities.
Emerging Markets Face Pressure Amid a Strengthening Dollar and ECB’s Stance
The ECB declared it will conclude quantitative easing this year but intends to maintain ultra-low interest rates for an extended period. Summarizing the key points, the market responded swiftly, with the euro plunging 1.75% against the dollar compared to the previous day’s close. In other words, the dollar surged 1.75% in value relative to the euro.
A rising dollar typically leads to weaker emerging market currencies, assuming other factors remain constant. While daily fluctuations are usually manageable, the current scenario is far more challenging. Emerging market currency markets have been volatile for months, with distressed sellers in countries like Turkey, Brazil, and Argentina ready to push values down further. The ECB’s unexpectedly dovish statement reignited selling pressure after a brief lull.
Rapid currency depreciation can create significant problems. Many EM businesses borrow in U.S. dollars, meaning their debt repayments become increasingly costly as their local currency weakens. For instance, the Argentine peso has lost 42% of its value since the start of the year, including Thursday’s drop. This surge in depreciation nearly doubles the interest payments for borrowers compared to January.
Besides domestic companies, multinational corporations with exposure to emerging markets also face profitability challenges when EM markets decline. For U.S. investors, this trend suggests that small-cap stocks, which are more domestically oriented, may continue to outperform larger multinational firms within the S&P 500.
The largest emerging markets equity ETFs by assets include the Vanguard FTSE Emerging Markets ETF (VWO), iShares Core MSCI Emerging Markets ETF (IEMG), and iShares MSCI Emerging Markets ETF (EEM).
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