With the continued strong rise of the US dollar, emerging markets are about to face a major impact...

On November 12, the Financial Times of the United Kingdom reported that the US election may just be the beginning of the US dollar's strong rise. Currently, the market's expectations for loose US fiscal policy are boosting economic growth expectations, lifting the stock market; the rise in US interest rates relative to other regions of the world is supporting the US dollar. Market will view tariffs as a negative impact on trade conditions, and countries affected by tariffs will experience currency devaluation to offset the loss of competitiveness.

Some analysts pointed out that if the US further implements even larger tariffs, bigger changes are imminent. For emerging markets, the currencies of Asian countries will face a "massive" devaluation, dragging down the currencies of other regions' emerging markets. The prices of commodities will also fall for two reasons:

• First, the market sees the tariff war and resulting instability as negative factors for global growth.

• Second, global trade is priced in US dollars, which means that when the US dollar appreciates, purchasing power in emerging markets is lost. Tightened financial conditions will also put pressure on commodities. At the same time, currencies of commodity-exporting countries will face stronger devaluation pressures.

In this environment, many currencies in emerging markets pegged to the US dollar will become even more fragile and face the risk of explosive devaluation, especially in countries like Argentina, Egypt, and Turkey. Analysts believe all of this indicates that now is a very bad time to be pegged to the US dollar:

"The US has a large fiscal space and appears determined to utilize it, which is bullish for the US dollar. Tariffs are just one manifestation of deglobalization, a process that will shift 'growth' back from emerging markets to the US, also benefiting the US dollar.

Finally, the rise in geopolitical risks has increased the volatility of commodity prices, exacerbating the probability of economic shocks. This makes exchange rates which are now completely flexible more valuable than in the past.

However, the analysis also points out that emerging markets have an "obvious" solution, which is to allow exchange rates to float freely and offset potential significant external shocks. Although large-scale devaluation may push up inflation, emerging markets' central banks have been quite adept at handling this issue:

Most of them have better coped with the inflationary impact brought by the COVID-19 pandemic than their counterparts in G10 countries, raising interest rates earlier and faster.

However, it is worth noting that a significant surge in the U.S. dollar could also cause lasting damage to the local currency bond markets of emerging markets. Currently, some economies have suffered losses because the sharp appreciation of the U.S. dollar over the past decade has eroded the gains foreign investors obtained through arbitrage trading.