In turn, a weaker U.S. dollar should be very good news for emerging markets, for many reasons. First, if the U.S. dollar weakens against all other currencies, then it follows that emerging markets’ currencies would appreciate against the U.S. dollar. Second, a weaker dollar tends to spur international capital flows to emerging markets. Third, strong empirical evidence suggests that a weaker U.S. dollar boosts commodity prices.
Commodity prices should gain support from three aspects of a weaker U.S. dollar. First is the direct valuation effect, as commodity prices are quoted in U.S. dollar terms. Second is the “financialization” of commodities: as commodity futures have evolved into a financial asset class, the link between prices and the financial transmission channel has become crucial. Third is the China link: because the Chinese currency is a “pseudo peg” against the U.S. dollar, a weaker U.S. dollar means a weaker RMB too, against a basket of other currencies. A weaker RMB would tend to be expansionary for the Chinese economy. China is a major global consumer and importer of commodities, and commodity prices tend to rise with increased Chinese demand.
In sum, a global backdrop of decent growth, low inflation and accommodative global monetary policies could feel like nirvana for emerging markets, along with a weaker U.S. dollar that could boost emerging markets currencies. While this environment could lift many emerging markets boats, commodity-exporting Latin America would likely benefit the most from a rising tide of commodity prices.
Commodity prices indeed matter a lot for currency valuation estimates in Latin America, as they are relevant for current account developments. In Brazil, for instance, Brazil’s real is highly correlated with commodities. Global prospects thus reinforce my long-held, high-confidence, out-of-consensus view that the Brazilian real will be much stronger this year than markets have anticipated: I see the real hitting 3.0 this year – if not stronger. In turn, a stronger real would also reinforce my high-conviction, long-held view that domestic interest rates in Brazil will fall to 7.0 percent (if not lower), well below what markets and consensus first expected.
Commentary by Marcelo Carvalho, head of Emerging Market Research, Latam at BNP Paribas. Follow him on Twitter @MCarvalhoEcon.
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