The EM Financial Stability Report Card | Rohit Goel on Emerging Markets, Dollar Dominance, and Term Premia
Feb 5, 2025
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Rohit Goel, a partner and head of global macro at Breakout Capital, dives into the complexities of emerging markets and the dominance of the U.S. dollar. He discusses how fiscal policies impact financial stability, especially amid currency fluctuations. Goel highlights the dual nature of a strong dollar, benefiting exporters while hurting equity markets. Additionally, he explores opportunities in agricultural commodities and the evolving dynamics of bond yields in China, along with the shift towards diverse currency reserves in a multipolar economic landscape.
Emerging markets have demonstrated remarkable resilience post-pandemic, with many achieving healthier balance sheets than initially anticipated through proactive economic stabilization measures.
Maintaining fiscal discipline is crucial for emerging markets to avoid excessive government spending that could jeopardize the financial stability gained during economic downturns.
The interplay between the U.S. dollar's strength and emerging markets significantly influences financing access, shaping debt management and investment strategies in response to currency fluctuations.
Deep dives
The Resilience of Emerging Markets
Emerging markets have shown impressive resilience in the face of global economic challenges, managing to emerge from the pandemic with healthier balance sheets than expected. Initially, the predictions suggested a wave of defaults in these markets; however, only a handful occurred, highlighting the ability of policymakers and corporations to effectively navigate crises. This resilience is attributed to proactive measures taken by many emerging markets to stabilize their economies, such as raising interest rates early to create monetary policy buffers. Nonetheless, fiscal risks remain a concern, as excessive government spending could undermine the stability achieved during tougher times.
Fiscal Discipline and Policy Orthodoxy
Maintaining fiscal discipline is critical for emerging markets, particularly as they face increasing pressure to loosen their fiscal balances amidst tighter growth conditions. Unlike developed nations, many emerging markets do not have the luxury of running large fiscal deficits without consequences. A cautious approach to fiscal policy, avoiding excessive spending, is essential for sustaining long-term growth and financial stability. The need for policy orthodoxy underscores the importance of focusing investments on productive areas rather than succumbing to the temptation of populist spending schemes.
Global Financial Conditions and Dollar Strength
The relationship between emerging markets and the strength of the U.S. dollar is complex, with fluctuations in the dollar impacting financing access for these countries. A rising dollar typically tightens domestic financial conditions, forcing higher yields on local currencies, which can deter foreign investment. Conversely, when the dollar weakens, emerging markets often perform better as global investors seek higher returns in those markets. This dynamic has significant implications for how emerging markets manage their debt and investor strategies, particularly in a context where reliance on foreign capital is high.
The Impact of Monetary and Fiscal Policy
The interplay between monetary policy and fiscal policy significantly affects emerging markets, with central banks often faced with the challenge of maintaining stability amid external pressures. Many emerging markets have responded to tightening global financial conditions with strict monetary policies, but excessive borrowing can lead to unsustainable debt levels. The challenge is particularly acute for frontier markets, which have limited access to capital relative to larger emerging economies. Policymakers must strike a balance between pursuing growth initiatives and ensuring long-term fiscal health to avoid future crises.
Market Dynamics and Investment Strategies
The evolving market dynamics in emerging economies have shifted investor preferences, with some regions becoming increasingly attractive while others face challenges. The growth potential in countries like India has seen valuations rise, but caution remains because high valuations must be justified by strong earnings growth. In contrast, Chinese assets are perceived as increasingly risky, despite their low valuation-for-investment ratios. Investors are increasingly focusing on fundamental analysis combined with macroeconomic perspectives to identify opportunities that withstand market volatility.
Gold's Resurgence Amid Geopolitical Tensions
Central banks, particularly in emerging markets, have increased their gold holdings significantly as a hedge against geopolitical tensions and currency volatility. After years of selling, banks are now diversifying their reserves, spurred by global economic uncertainties that have emphasized the need for stability outside traditional fiat currencies. This trend has driven up gold prices, signifying a shift in reserve management focusing on asset diversification away from the dollar. The motivations for this shift are often rooted in the desire to protect national interests against possible sanctions and economic disruptions.
Rohit Goel, partner and head of global macro at Breakout Capital, joins Monetary Matters to share his views on emerging markets, the dollar, and bond market term premia. Recorded on January 16, 2025.
