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Key points:

  • The U.S. dollar – as measured by the Federal Reserve’s Trade Weighted Dollar Index – is up by about 9% since the start of 2018. Its rise has been a crucial driver of asset performance over the last two years.
  • While the dovish pivot by the Fed eased financial conditions globally, the dollar remained resilient amid year-to-date bids for safe havens and relatively high interest rates than other developed market regions.
  • We are overweight emerging market (EM) equities, as we believe EMs are poised to be beneficiaries from the global economic recovery. However, although a Fed on pause could weaken the dollar, should further dollar strengthening occur, it would be a potential headwind to EMs, particularly those with high financing needs and weak external positions.


The U.S. dollar – as measured by the Federal Reserve’s Trade Weighted Dollar Index – is up about 9% since the start of 2018.1 The factors behind the currency’s rally are varied, but several developments stand out in particular.

  • Carry trade: Widening growth differentials between the U.S. and comparable developed market (DM) economies have been manifested in interest rates. This led to a revival of the “carry trade,” where investors borrowed in lower-yielding currencies such as the euro or Japanese yen, and invested in higher yielders like the dollar, pocketing the difference in yield. We see this trend as a key driver of currency movements in the short run.
  • Global monetary policy: Major central banks did not follow the Fed tightening in 2018, but joined in Fed easing in 2019. In 2018, the Fed tightened monetary policy while other global central banks remained in accommodative territory. In 2019, the Federal Reserve reversed course and cut rates, and other major central banks followed suit.
  • Demand for U.S. assets: Global attraction to U.S. based assets is another tailwind for the dollar. Rising protectionism and geopolitical tensions influenced demand for U.S. Treasuries within sovereign bonds and a preference for U.S. equities relative to global exposures.

EM impact:

The dollar is the nexus between asset classes. It affects borrowing costs and commodity prices, is a proxy for risk appetite, influences global capital flows and is a central transmission channel for global financial conditions. Therefore, the currency is a key driver of emerging market (EM) asset performance. Figure 1 identifies the Trade Weighted U.S. dollar’s weekly correlation to the MSCI All Country World Index (ACWI), MSCI Emerging Markets (EM) dollar and local currency indexes, and the JP Morgan Emerging Market Bond Index from 2009 to 2019. Though all exposures have a negative correlation the dollar, EM unhedged equities have the most negative correlation to the dollar at -0.69.

Correlation of weekly returns (Dec 2009 – Dec 2019)

Source: BlackRock, Thomson Reuters, as of 12/18/2019. Index performance is for illustrative purposes only. Index performance does not reflect any management fees, transaction costs or expenses. Indexes are unmanaged and one cannot invest directly in an index. Past performance does not guarantee future results.

Furthermore, the magnitude of the dollar’s impact on an EM economy is exacerbated by that country’s external position as a stronger dollar increases the debt servicing costs of international dollar debt borrowers. Over the last 12 months, EM countries with larger external financing needs, like Turkey and Argentina, saw the greatest jump in borrowing costs and steepest foreign exchange (FX) and equity losses. Countries with strong balance of payments saw their currencies and borrowing costs largely contained.

Flows and positioning

EM equity ETPs are exhibiting a better year than in 2018. Broad EM and single country products have gathered $6.9bn in cumulative assets YTD.2 Still, the dollar’s negative relationship with EM assets manifests in primary market ETF flows, too. Over the past year, the months that saw the largest increase in the U.S. trade weighted dollar index (August and May) were accompanied by the worst outflows from EM equity ETPs (figure 2).

Figure 2: ETF flows and US trade-weighted dollar

ETF flows and US trade-weighted dollar

Source: Thomson Reuters, Federal Reserve, as of 12/18/2019. Flows are subject to change.


The dollar had an impressive run over the last two years. While the Fed has cut rates three times in 2019, the same factors that drove the Fed –slowing global growth and tightening financial conditions– also pushed other central banks toward a more dovish stance. The dollar’s perceived “safe haven” role is likely to boost the greenback in the event of any return of recession fears or a resurgence in geopolitical risk. The dollar’s relatively high valuation may limit its upside in the long term. The real effective exchange rate–a key trade-weighted gauge of the dollar’s value – is sitting roughly one standard deviation above the 20-year average.3

With respect to EM equities, we are overweight on the asset class but stress that different opportunity sets should continue to drive performance and risk differentials throughout the region. Additionally, with a Fed that is no longer in restrictive territory and the potential for a recovery in global growth, the dollar may have room to weaken. Therefore, this should allow investors to focus on individual EM country fundamentals.

Christopher Dhanraj
Head of iShares Investment Strategy
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