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 presidential election may just be the starting point for the strong rise of the US dollar. Currently, the market's expectations for loose US fiscal policy are increasing growth expectations, boosting the stock market; the rise in US interest rates relative to other parts of the world is supporting the US dollar. Meanwhile, the market views tariffs as a negative impact on trade conditions, as countries affected by tariffs will devalue their currency to offset the loss of competitiveness.

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

• Firstly, the market sees tariff wars and the accompanying instability as negative factors for global growth.

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

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

"The US has a lot of fiscal space and seems determined to use it, which is bullish for the US dollar. Tariffs are just a manifestation of de-globalization, a process that will 'shift' growth away from emerging markets back to the US, also benefiting the US dollar.

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

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

Most of them have better handled the inflation shock caused by the COVID-19 pandemic than their counterparts in G10 countries, raising interest rates earlier and faster.

However, it should be noted that a significant surge in the US dollar could also cause lasting damage to the local currency bond markets of emerging markets. Currently, some economies have suffered losses as the sharp rise in the US dollar over the past decade has erased the profits that foreign investors obtained through arbitrage trades.