Is the dollar finally done?

In the massive tug of war that is the foreign exchange market, the burly U.S. dollar has pulled the world’s major currencies into the mud all year. But as global bond markets began to stabilize in October and trade in a more balanced fashion, the broad nondollar group might finally be pulling the rope back. With financial stability restored in the U.K., fears of global financial contagion receding and market volatility dissipating, investor appetite for risk has returned. That’s diminished the dollar’s haven premia, helping the bulk of G-10 currencies to garnish substantial gains against the greenback in October. 

While some debate remains, an eurozone recession appears unavoidable. The purchasing managers index for its service sector, a reliable economic barometer for the euro area, slipped even deeper into recessionary territory in October, and the manufacturing component fell to its lowest since May 2020. The continuing loss of purchasing power due to high inflation is leaving ever larger scars on private consumption, practically guaranteeing a deeper economic contraction is on its way. In the U.K., benchmark government bonds and the pound have recovered from their post “mini-budget crisis” losses—both ultimately posted positive returns in October. But inflation that month reaccelerated to a 40-year high, assuring an already hawkish Bank of England will keep raising rates (its 75 basis-point hike last week matched the Federal Reserve’s), deepening recession fears there. Still the dollar’s dip against developed Europe appears to be holding,

Dollar weakening has extended to emerging markets (EM) recently. That’s good news for EM issuers, which service part of their debt in the currency. Reflecting this, the Bloomberg EM Seasoned ex Agg/Eurodollar and JP Morgan EMBI Global Diversified indexes had positive returns in October. This performance showcases the resiliency of the asset class in the face of a panoply of difficulties beyond the dollar’s strength: interest-rate volatility, global monetary policy shifts amid soaring inflation, global energy and food crises, geopolitical risks and a broad global risk off. But having already run this gauntlet, EM debt seems to have priced-in many of the theses issues, which are now catching up with other asset classes. In the coming months, these corporate and government bonds should face fewer external vulnerabilities. If this trend holds firm into next year, emerging markets could present investors with compelling value across the asset class.