Risk aversion signified by a rising dollar index may keep emerging markets (EMs) in check for the rest of 2013. The dollar index with which EMs, including India, hold a strong negative co-relation has rallied nearly 5% to 84.5 since mid-June after the US Fed announced its plans to taper its quantitative easing programme on the back of a recovering US economy. Over the same period, the MSCI emerging market index lost more than 4% even though the MSCI world index representing developed markets has declined less than 1%.
Currently the dollar index ? a gauge of the US dollar?s strength against a basket of six currencies, including the euro, British pound and Japanese yen ? stands at its highest level in three years. Given historical trends, if the index trades above 85-85.6 for an extended period, the correction in the EMs may deepen further.
According to Andrew Holland, CEO, investment advisory, Ambit Capital, besides risk aversion, the rising dollar index also represents a healthy recovery in the US economy. ?In the wake of winding up of easy liquidity, investors are preferring developed markets like US, Japan and certain European countries, given that are showing visible signs of economic recovery while most of the emerging markets are facing slowdown,? said Holland.
Since July 2008, on the three occasions when the dollar index has appreciated by more than 10%, the MSCI emerging market index has lagged the MSCI world index. In the latest instance, the dollar index has appreciated almost 16% from its low in April 2011, pushing the MSCI EM index down by 24%, though the MSCI world index has added 6%. Since the bear market of 2008, a substantial rise in the dollar index, that generally follows increased uncertainty in the global financial markets, weighs more on the EMs than developed markets.
The dollar index not only gives a fair sense of the aggregate value of the greenback, but also highlights the safe-haven status of the US currency. Because of this status, it holds a strong negative correlation with the global equity markets, especially EMs that are perceived to relatively high-risk investments. In the last decade, the dollar index maintained a negative correlation of 80% with the MSCI Emerging market index and 76% with the Sensex, 30-share Indian benchmark.
In a recent media interaction, Nomura global markets research said that among the Asia ex-Japan universe, Indian and Indonesian equity markets bear a higher risk to a swift unwinding of the QE program and a subsequent rally in the dollar.