'Weak Dollar = Emerging Market Currency Strength' Formula Broken

"Expansion of Government Fiscal Spending Makes Currency Value Increase Difficult for Now"
Emerging Market Bond Assets Recover, Differentiated by Country

[Asia Economy Reporter Minji Lee] Despite a decline in the value of the dollar and rising commodity prices, the recovery of emerging market bond assets has been slow. In the case of Brazilian government bonds, which boasted an annual expected return of over 10%, the formula 'weak dollar = strong emerging market currencies' is not holding due to the deterioration of national fiscal soundness caused by the novel coronavirus disease (COVID-19).

On the 12th, according to the financial investment industry, the Brazilian real exchange rate was 5.4 reals per dollar as of the previous day, showing an upward trend again after falling to 4.8 reals in June. The number of deaths due to the spread of COVID-19 sharply increased, and on May 13, the rate nearly reached 6 reals per dollar. As a result, the evaluation loss of 10-year Brazilian government bonds in the first half of the year was recorded at 16.4%. Although this is a significant recovery compared to April, when the evaluation loss was 30% amid great fear of COVID-19, it is expected to take more time for the yield to turn positive.

[Image source=Yonhap News]

The factor that directly affects bond yields is the currency value. As the currency value falls, the yield on bond assets decreases. Empirically, non-dollar assets tend to attract attention during a weak dollar phase. Commodity prices, which move inversely to the dollar, have also been rising, so the value of the Brazilian real, which exports oil and iron ore, is bound to increase.

However, the biggest factor dragging down the real's value is concerns over excessive spending by the Brazilian government. The government is expected to inject an additional 70 billion reals (15.5 trillion won) in fiscal funds as it considers extending disaster relief payments related to COVID-19 fiscal policies.

Hyun Tae Yeo, a researcher at Korea Investment & Securities, said, "Until last month, the possibility of extending the deadline seemed low due to the heavy fiscal burden, but increasing fiscal support will deepen the financial market's concerns about government debt," adding, "There has been no progress in tax reform to expand national finances, so it will be difficult for the real's value to turn upward."

Meanwhile, Russia and Mexico are recovering faster than Brazil. The Russian ruble surged to 80.38 rubles per dollar after the spread of COVID-19 in March but has stabilized at 73 rubles currently. The rise in oil prices and the government's swift fiscal policies influenced this. Mexico also surged from 18 pesos per dollar in March to 25 pesos but currently records 22 pesos, with upward pressure easing.

Shin Hwanjong, a researcher at NH Investment & Securities, explained, "Although the economy has contracted due to the COVID-19 crisis and the sharp drop in oil prices, countries like Russia and Mexico with solid fundamentals among emerging markets are attracting global investment funds, so asset prices are expected to strengthen."

This content was produced with the assistance of AI translation services.