Latest / The Emerging Markets Podcast with Fexingo: Developing Economies, Growth, and Investment / How Emerging Market Currencies Are Quietly Rebuilding Reserves
Transcript
- Lucas: So the trade-weighted dollar index is sitting at 119.1 as of this week, down from 119.5 a month ago. Not a huge move, but it's the first real pullback we've seen in months, and it's got me looking at something we haven't talked about on this show: what emerging market central banks are doing with their foreign exchange reserves. Luna: Reserves? That feels like a topic we usually skip in favor of equities. But I'm curious — what's the connection to the dollar's retreat? Lucas: Right, because for a lot of EM countries, the dollar is the anchor. When the dollar strengthens, their currencies come under pressure, and they often have to burn reserves to defend them. But when the dollar eases, even slightly, it gives them room to rebuild those buffers. And the data suggests that's exactly what's happening in 2026. Luna: So you're saying the dollar's dip is letting them restock the war chest? Lucas: Exactly. Look at the recent balance of payments data. The US trade deficit narrowed from 77.6 billion to 73.3 billion in June, and exports are up. But that's the US side. For EM, the story is that countries like South Korea and Taiwan are running current account surpluses, and they're choosing to hold onto those dollars rather than let their currencies appreciate too much. That's reserve accumulation. Luna: And South Korea's market has been on fire lately — the EWY ETF is up ten and a half percent in five days. Is that related? Lucas: Partly, but the reserve story is more about stability than short-term performance. When a central bank accumulates reserves, it's signaling that it can defend its currency if needed. That reduces currency risk for foreign investors, which can support both equities and bonds. But there's a nuance — not every EM country is in a position to do this. Luna: Let me guess: the ones with big deficits are still in trouble. Lucas: Right. Turkey and Argentina come to mind. They've been running persistent deficits and have thin buffers. A stronger dollar hits them harder. But the countries that have been careful — I'm thinking of India, which has been steadily building reserves for years — are in a much better position to weather the next dollar spike. Luna: I remember India's market rode out the global selloff pretty well back in episode 149. Maybe that's part of the reason. Lucas: That's a great connection. India's central bank has been buying dollars whenever the rupee strengthens, and that's built a cushion. So when the selloff hit, they didn't have to scramble to defend the currency. They had the dry powder. And you see that in the relative stability of their market compared to, say, China's. Luna: Speaking of China, the yuan has been flat at 6.75 per dollar. But Chinese stocks are down — JD dropped over ten percent in five days. That's not exactly a vote of confidence. Lucas: No, and that's a different story. China's reserves are huge, but they've been managing capital outflows, and the market is reacting to policy uncertainty and earnings concerns. The reserve build is more of a story for the countries that are exporting into a recovering global economy. South Korea's exports have been strong, and Taiwan, too, despite the geopolitical noise. Luna: So is the reserve accumulation a coordinated strategy, or is each country just doing its own thing? Lucas: Mostly each country doing its own thing, but they're all responding to the same incentive. When the dollar eases, your currency strengthens, which makes your exports less competitive. So you intervene, buy dollars, and add to reserves. It's a classic mercantilist reflex. But the scale matters — some countries are accumulating at a pace that suggests they're deliberately building a war chest. Luna: And what does that mean for bond investors? I know we've done episodes on EM bond yields, but this seems like a different angle. Lucas: It is. When reserves are solid, the risk premium on EM debt tends to shrink. Investors worry less about a currency crisis, so they accept lower yields. That's been showing up in the spread between EM bonds and US Treasuries. It's not a huge move, but it's there. Luna: But I've also seen headlines about the 30-year Treasury yield hitting five point three one percent, the highest in nineteen years. That's got to be pulling capital back to the US, right? Lucas: It is, and that's the counterweight. Higher US yields tend to attract global capital, which strengthens the dollar and puts pressure on EM. So even with the dollar off its highs, the yield picture is a reminder that the environment is still tricky. The countries with strong reserve positions are the ones that can ride that out. Luna: Makes sense. So how do we, as investors, actually track this? I'm not going to dig through balance of payments tables every week. Lucas: Good question. The easiest is to watch the central bank data — most publish their reserves monthly. But a shortcut is to look at the currency's behavior. If a currency is stable while the dollar is moving around, that's often a sign the central bank is intervening. And you can also look at the forward market for clues. Luna: So, what's the one takeaway you want listeners to remember from this? Lucas: That reserves are the quiet foundation of EM stability. They don't make headlines, but they determine how a country weathers the next storm. And right now, the countries that have been building reserves are the ones you want to be invested in. Luna: That's a solid takeaway. And I have to say, if today's episode was useful, it's because we get to dig into these topics without sponsors breathing down our necks. The way to keep that going is listener support. Lucas: Yeah, we really appreciate the folks who throw a few dollars our way. If today's episode helped you connect the dots, you can buy us a coffee at buy me a coffee dot com slash fexingo. It keeps the show ad-free. Luna: And it lets us spend the time pulling the data apart. Now, back to the reserves — I want to talk about the mechanics of intervention, because it's not as simple as 'buy dollars when the currency strengthens.' Lucas: Right, there are real constraints. If you buy too much, you create inflation by expanding the money supply. That's why some central banks sterilize the intervention — they sell bonds to mop up the extra liquidity. It's a delicate dance. Luna: And some countries do it more aggressively than others. Who's been the most aggressive lately? Lucas: I'd point to Taiwan. They've been accumulating reserves for years, and they're not shy about intervening to keep the currency from appreciating too much. Their export machine depends on it. South Korea too, though they've been a bit more measured. India is building steadily, but they're also letting the rupee appreciate gradually, so they're not fighting the market as hard. Luna: So it's not just about the amount, but the approach. Lucas: Exactly. And that's what makes this a rich topic. The countries that are most successful at this are the ones that signal they have a strategy, not just a reaction. That builds credibility, which is worth its weight in gold for a central bank. Luna: Credibility — that's the intangible asset. And I guess it shows up in the market's reaction to bad news. A country with credibility doesn't get punished as hard when something goes wrong. Lucas: That's the beauty of it. Think about the episode we did on Brazil — the market split reflects a broader divide between growth and yield. Reserves play into that. Brazil has decent reserves, but the political noise undermines credibility. Compare that to South Korea, where the policy framework is seen as stable, and you see why investors cut them more slack. Luna: So, for the investor listening, is there a practical way to use this? Like, should I be looking at reserve data before buying an EM ETF? Lucas: It's one factor. You wouldn't base a decision solely on it, but it's a good screen. The countries with strong reserve positions and a credible central bank tend to have lower volatility and better risk-adjusted returns over time. It's a quality factor, if you will. Luna: And with the dollar expected to stay elevated for a while, that quality factor becomes more important. Lucas: Exactly. The dollar's not going to collapse, but the days of it surging are probably behind us for now. That gives EM countries a window to rebuild their defenses. The ones that use it well will come out stronger. The ones that don't will be exposed. Luna: I like that. So, what do you think — are we going to see a clear divergence between the haves and have-nots in EM over the next year? Lucas: I think we already are. The market is rewarding the countries with strong fundamentals. You've got South Korea up double digits in a week, while China's tech names are getting hammered. That's not just about AI or earnings — it's about the confidence that comes from a stable macro backdrop. Luna: And a stable macro backdrop starts with a solid reserve cushion. Lucas: Right. It's the first line of defense. And the countries that are building it now are the ones that will be standing when the next shock hits. Luna: Well, I'm going to start paying more attention to reserve data. It's like the credit score of countries. Lucas: That's a good way to put it. And we'll keep an eye on it in the coming episodes. For now, I think we've given you a solid framework to think about it.