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Summary:

  • The cyclical factors that have supported the US dollar are eroding, while structural factors remain a challenge, in our view.
  • Emerging markets in general have shown resolve and robust policy responses during the pandemic and its aftermath, improving their economic fundamentals.
  • Beyond emerging markets, we think a sea change in Japan remains an exciting prospect.
  • We believe there are therefore a number of attractive options globally to diversify away from a weakening US dollar.
  • Risks to our outlook remain, including currency volatility and the possibilities of financial shocks or geopolitical events.

The US dollar: no rosy outlook here

In our view, the highs the US dollar attained in 2022 represent the peak of the current cycle. Currencies exhibit volatility and episodic reversals even during the course of a cycle, so even though the dollar has broadly moved sideways thus far in 2023, our view remains that the cyclical supports to the dollar’s strength are waning.

Emerging markets: proving their mettle

While there have been cyclical timing differences between regions, inflation has generally peaked, and interest-rate cycles are following suit. Latin America generally saw inflation surge before other regions, but also saw policymakers react swiftly, with the result that inflation in several countries has either stabilized or shifted into a downtrend, and we have already seen some central banks in the region start to reduce rates.

Japan: undergoing a sea change

The economic environment in Japan is changing meaningfully compared with the past couple of decades. The slow growth/very low inflation environment that had characterized the country has now given way to more sustained growth and inflation.

WHAT ARE THE RISKS?

All investments involve risks, including possible loss of principal. The value of investments can go down as well as up, and investors may not get back the full amount invested. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions. Investments in foreign securities involve special risks including currency fluctuations, economic instability and political developments. Investments in emerging markets, of which frontier markets are a subset, involve heightened risks related to the same factors, in addition to those associated with these markets’ smaller size, lesser liquidity and lack of established legal, political, business and social frameworks to support securities markets. Because these frameworks are typically even less developed in frontier markets, as well as various factors including the increased potential for extreme price volatility, illiquidity, trade barriers and exchange controls, the risks associated with emerging markets are magnified in frontier markets. To the extent a strategy focuses on particular countries, regions, industries, sectors or types of investment from time to time, it may be subject to greater risks of adverse developments in such areas of focus than a strategy that invests in a wider variety of countries, regions, industries, sectors or investments.

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