Latest / The Emerging Markets Podcast with Fexingo: Developing Economies, Growth, and Investment / How the Strong Dollar Is Reshaping Emerging Market Debt
Transcript
- Lucas: So you look at the headlines on a Friday like today, June 26, 2026, and there's a lot of noise — Iran ceasefire violations, trade war threats, inflation ticking above four percent. But if you're watching emerging markets, there's really one story that cuts across everything else, and it's the US dollar. Luna: Yeah, it's been relentless. The trade-weighted dollar index — the broad measure, not just against the euro or yen — hit 120.4 this week. Lucas: Right. That's up from 119.4 just last week, and it's been grinding higher for months. For context, that index was around 118 at the start of 2024. So we're in territory that's historically been painful for any country that borrowed in dollars. Luna: And you see it in the ETF flows. EEM, the big emerging markets ETF, is down almost six percent in five days. VWO, which tracks a broader index, down about four and a half. Lucas: But what I find more telling is the dispersion beneath the surface. Some markets are getting hammered much harder than others. Let's take Korea — the EWY ETF, which tracks Korean stocks, fell more than nine percent this week. Taiwan's EWT dropped eight percent. That's not just dollar strength, that's a flight from tech-heavy exporters who are seeing their products get more expensive in dollar terms. Luna: And those are supposed to be the 'good' emerging markets. Strong manufacturing bases, current account surpluses. If they're getting hit this hard, what does it mean for the ones with real currency mismatches? Lucas: Exactly. That's the core issue. A lot of emerging market companies and governments took on dollar-denominated debt when rates were low and the dollar was weaker. Now the dollar is strong, their local currencies are under pressure — the yen is past 161 per dollar, the yuan is at 6.77, and that's with the PBOC actively managing it — so the real burden of that debt is inflating in local currency terms. Luna: I remember a paper from the Bank for International Settlements that estimated that for every ten percent rise in the dollar, emerging market GDP growth falls by about half a percentage point in the following year. Through the debt channel. Lucas: That's exactly the mechanism. And it's not just GDP — corporate defaults tend to rise. But here's where it gets interesting: not every market is suffering equally. Brazil's EWZ ETF is actually up one point two percent this week. So what's different? Luna: Commodities, I assume? If the dollar strengthens, dollar-denominated commodity prices usually fall, but Brazil is a net exporter of oil, iron ore, soybeans — and a lot of that is priced in dollars anyway. So maybe the currency depreciation helps their exporters? Lucas: That's part of it. Brazil's real has weakened, but not as much as some Asian currencies. And because the economy is more commodity-driven, investors see it as a hedge against a global slowdown. Plus, the central bank has been aggressive with rate hikes — the Selic is still above 14 percent — so you're getting a real yield that's attractive in a world where the ten-year Treasury is yielding around four and a half percent. Luna: So it's basically a carry trade play. But that can reverse quickly if risk appetite turns. Lucas: Absolutely. And that's the thing about this environment — the dollar strength is partly a flight to safety in a world with geopolitical uncertainty, but it's also self-reinforcing. As the dollar rises, emerging market assets get sold, which pushes the dollar even higher. The Fed isn't helping — Chair Warsh is under political pressure from Trump to ease, but inflation is above four percent, so they're stuck. Luna: And meanwhile, you've got Trump threatening 100 percent tariffs on countries that impose digital services taxes. That's a direct threat to economies like India, Indonesia, even some European countries — but also to the emerging markets that have been trying to tax big tech. Lucas: Right. So it's not just a macro story, it's a policy story. The strong dollar is amplifying the impact of trade tensions. A country like Vietnam, which has benefited from supply chain shifts away from China, now faces a double whammy: its exports get more expensive in dollar terms, and it risks tariff retaliation. Luna: Let's talk about one specific case that I think illustrates the danger. I was looking at the debt maturity wall for Turkey. They have a lot of dollar-denominated corporate debt coming due in 2027. If the lira keeps weakening — it's already down something like 30 percent against the dollar over the past 18 months — the cost of servicing that debt in local currency terms is going to be brutal. Lucas: Turkey is a classic example. They've been running unorthodox monetary policy for years, even after the 2023 election pivot. The lira is under constant pressure, and inflation is still high. If the dollar keeps rising, you could see a wave of corporate defaults. But the government has been stepping in with various schemes — fx protected deposits, that sort of thing. Luna: Does that actually work, or is it just kicking the can down the road? Lucas: It's a Band-Aid. The underlying problem is that the economy needs foreign capital to finance its deficits, and when the dollar is strong, that capital becomes more expensive and harder to attract. Eventually, something has to give — either you hike rates enough to defend the currency, which crushes growth, or you let it devalue and deal with the inflation and default consequences. Luna: So as an investor right now, what do you do? Do you just avoid emerging markets entirely until the dollar peaks? Lucas: Not entirely, but you have to be selective. The markets that are most vulnerable are the ones with high dollar debt, large current account deficits, and weak institutions. That includes Turkey, Argentina, South Africa. The ones that are more resilient tend to be commodity exporters with strong fiscal positions — think Brazil, Saudi Arabia, even Indonesia to some extent. And then you have the outliers like India, which is more domestically driven and less exposed to dollar debt, but still sensitive to capital flows. Luna: India's ETF, INDA, was down less than one percent this week. So that fits the narrative. Lucas: Yeah, India is interesting because it's a large domestic economy, so it's somewhat insulated from trade shocks. But they're not immune. If global risk appetite dries up, foreign investors will pull money out of Indian stocks and bonds, and the rupee will weaken. The RBI has been intervening to smooth the volatility, but they can't hold back the tide forever. Luna: Speaking of which, I want to come back to the China angle. Chinese stocks have been getting hammered — Alibaba down ten percent in five days, JD down seven, Baidu down almost seven. The MSCI China ETF is down nearly five percent. Is that all dollar-driven, or is there more going on? Lucas: It's a combination. The strong dollar is part of it, but China also has its own domestic problems — deflationary pressures, a property sector that still hasn't bottomed, and a government that seems reluctant to do massive fiscal stimulus. Plus, the trade tensions are escalating. So Chinese stocks are getting hit from multiple directions. Luna: And the yuan is being held steady at 6.77, but that's only because the PBOC is selling dollars to defend it. If they stop, the yuan could weaken significantly, which would then put more pressure on other Asian currencies. Lucas: Exactly. And that's the risk of competitive devaluations. If China lets the yuan slide, you get a round of weakening across Asia, which then makes the dollar even stronger. It's a vicious cycle. Luna: So what's the trigger that could break this cycle? Is it a Fed pivot? Or a resolution to some of the geopolitical tensions? Lucas: I think the most likely catalyst is a shift in Fed policy. If inflation starts to come down — maybe due to the dollar itself reducing import prices — the Fed could signal a pause or even cuts. That would take some steam out of the dollar rally. But the opposite scenario is also possible: if inflation stays sticky, the Fed keeps rates high, the dollar keeps climbing, and something breaks in an emerging market. Luna: Historically, when the dollar gets this strong, there tends to be a crisis somewhere. In the 1980s, it was the Latin American debt crisis. In the late 1990s, it was Asia. In 2015, it was the emerging market sell-off. Lucas: Right. And we're already seeing stress. The KRW and TWD have been weakening sharply. Some frontier markets like Sri Lanka and Pakistan are already in trouble. But the real test will come when the next wave of dollar debt matures — a lot of it was issued during the pandemic when rates were low, and the maturities are concentrated in 2027 and 2028. Luna: Have you thought about this: the strong dollar is actually helping the US economy by keeping import prices in check, but it's hurting US companies with overseas revenue. So it's not just an EM problem. Lucas: That's a great point. S&P 500 companies get about 40 percent of their revenue from abroad. A strong dollar reduces the dollar value of those earnings. So it's actually a headwind for US stocks too, which is part of why the market is struggling this week. Luna: Right. So it's all connected. And that's what makes this moment so fascinating — and a bit scary. Lucas: Yeah. And speaking of what's worth paying attention to, I want to take a quick moment here. If walking through the economy with us has made something click for you today — maybe you finally understood why the dollar matters for your own portfolio, or you're just getting value from the show — honestly, if today was worth a coffee to you, that's the link. It's buy me a coffee dot com slash fexingo. Luna: Yeah, it's a small gesture that keeps this show free and independent. We don't run ads, so listener support is what keeps us going. No pressure, truly. Lucas: And we appreciate everyone who listens. So back to the dollar — let's wrap up with one forward-looking thought. The question I keep asking is: which emerging market will be the first to break? And I think it's going to be one that has a combination of high dollar debt, a large current account deficit, and political instability. Turkey fits, but they've been living on the edge for years. Argentina is already in crisis. The one I'm watching is South Africa. Luna: South Africa — they have a lot of dollar debt, weak growth, and the rand is already under pressure. And they just had elections that resulted in a coalition government, which could make policy reform harder. Lucas: Exactly. So if the dollar keeps rising, that's where I'd expect to see the next episode of stress. But for now, we're in a wait and see mode. The data next week — PMIs, inflation numbers — will tell us a lot about whether this trend is accelerating. Luna: We'll be watching. Thanks for joining us.