While the halo effect of China’s ongoing growth story is a major influence on other Asian economies, US fiscal and monetary policy also has a significant effect on these countries. Given the bearish outlook for US interest rates, Asian emerging markets (EM Asia) could benefit from a weaker US dollar.

While the US dollar continues to offer a potential safe haven for investors, and has benefited accordingly, there are concerns about the fiscal health of the US. The US has spent heavily on recovering its economy from the Covid-19 pandemic, with total fiscal stimulus that could end up being 40% higher than similar interventions elsewhere in the world, assuming a fourth stimulus package is eventually passed.

This is starting to point towards a more depressed outlook for the US currency – which could be positive for EM Asia.

A weakened US dollar could boost Asia’s emerging markets

There are several reasons why ultra-low US interest rates and a structurally weak US dollar are positive for EM Asia:

• The resulting positive real yield (yield after inflation) offered in EM Asia could prove attractive to international bond inflows. Although Asian central banks have also cut rates to support their domestic economies in the wake of the Covid-19 pandemic, the region is still able to offer positive real yield to investors.
• Stronger EM Asia currencies relative to the US dollar could help improve Asia’s balance of payment position, attracting capital inflows and reducing the foreign-debt burden. This is particularly beneficial to economies like Indonesia, India and the Philippines, which need foreign inflows to finance their current account deficits (the gap between the value of imports and exports) and which have higher foreign-currency-denominated debt. EM Asia economies generally have increased their US dollar debt over the past decade, particularly in the private sector, so a weaker US dollar would help reduce the foreign currency debt stock, and service burden.
• A weaker US dollar would reflect the relative outperformance of emerging markets (EMs) compared with developed markets; this outperformance could also be the result of stronger global trade. We anticipate that the weakening of the US dollar is likely to coincide with the world economy gradually stepping out from the impact of Covid-19, and global trade recovering from its current state.

The dollar is far from the only factor that will determine EM Asia’s economic success. For example, each economy’s relative success in containing the pandemic will be critical in driving Asian economies’ macro performance.

To this end, we maintain our view that North-East Asian economies like China, South Korea and Taiwan – which are included in the MSCI Emerging Markets Index and so classed as EMs – are leading the region. They have managed to get Covid-19 largely under control while their domestic economies have been able to recover and resume normal operation without excessive stimulus support – either fiscal or monetary.

Investment implications

EM equities generally tend to outperform those in developed markets during periods of US dollar weakness, and EM Asia is no exception. The DXY (US Dollar Index index tracks the dollar’s value relative to the currencies of the US’s most significant trading partners. Historically it has been negatively correlated with the relative equity performance of EMs versus developed markets. Although this negative correlation has somewhat weakened in recent years, it continues to support our view that the relative strength of EM currencies versus the US dollar reflects both the global business cycle and the growth fundamentals of the EM world.

We would also expect EM credit spreads (the difference in yield between EM securities and US bonds) to tighten during periods of US dollar weakness. Historic data suggest that EM credit spreads are inversely correlated with EM currency strengths and commodity prices. As such we maintain our recommendation that investors increase exposure towards good-quality corporate credit in Asia.

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