Facebook
Twitter
Now that the Federal Reserve has finally put to rest the nonstop debate over whether it would raise interest rates this year, the next question is which markets will win and which will lose.
The decision to hike interest rates for the first time since 2006 is widely expected to further boost the U.S. dollar, which has already rallied considerably against most other global currencies over the past year. If that is indeed the case, an even stronger U.S. dollar is likely to put pressure on international markets.
Emerging Markets in the Cross Hairs
The economies most vulnerable to a stronger U.S. dollar are the emerging markets – in particular, the “BRIC” nations, a term that includes Brazil, Russia, India and China. These four nations are considered to be the premier emerging markets right now.
The reason why emerging markets are likely to suffer is that they are currently among the most rapidly growing economies in the world, and as such, have the most to lose from continued strength in the U.S. dollar.
The rally in the dollar over the past two years has coincided with a dramatic decline in the price of commodities. A wide range of commodities – including oil, natural gas and precious metals – have dropped by 50% or more in that time. This would be a significant negative for several emerging markets, including Brazil and Russia.
Brazil and Russia are major energy producers. Their economic growth relies heavily on oil and gas, so a continued decline in commodity prices would put significant pressure on their economic growth. For example, the International Monetary Fund sees Brazil’s economy contracting by 0.3% this year.
Why China May Buck the Trend
China is another premier emerging market, and while it has also seen a notable slowdown in economic growth over the past year, its economy may prove more resilient than Brazil and Russia. That’s because China is not overly dependent on exports of natural resources for economic growth. Instead, its booming consumer class could be the main driver of future economic growth. Consider that China is a country with a population exceeding 1 billion.
Along with this, China’s middle class is expanding rapidly, thanks to its strong economic growth. This economic expansion has vaulted millions of people into the middle class, leading to growth in spending among Chinese consumers.
The decision by the IMF to include China as a global reserve currency should help support the country’s economy. Earlier this month, the IMF announced that the Chinese yuan, also known as the renminbi, would officially be included as a reserve currency. This was a landmark step, as previously there had only been four reserve currencies: the U.S. dollar, the Japanese yen, the euro and the British pound.
As a global reserve currency, China could see increased demand for the renminbi, now that it will play a much greater role in international finance. Greater demand should result in an increase in the value of the renminbi. And a stronger currency is typically viewed as a sign of a strong economy. While its exports could become less competitive, the Chinese consumer stands to benefit from a stronger Chinese economy.
Tread Carefully in the Emerging Markets
The emerging markets have been among the world’s worst-performing stock markets over the past year. For example, the iShares MSCI Emerging Markets ETF (NYSEArca: EEM) has declined 13% year-to-date. This trend should continue now that the Federal Reserve has raised interest rates in the United States, which should further support the U.S. dollar.
That means that emerging markets, particularly those that are dependent on natural resources, could continue to slow down. Of the major emerging markets, China appears to be best-equipped to handle the current environment.
How to Sleep Easy at Night
Is the economy keeping you up at night? Do you worry there’s another crash just around the corner? If so, you can stop worrying right now. All it takes is a few minutes.