The depreciation of the US dollar breaks the traditional shackles! Emerging market currencies are freed from the constraints of US debt and ushered in the biggest trend divergence in four years

The Zhitong Finance App notes that US bonds and emerging market currencies are showing the greatest divergence in the past four years. The main reason is that higher US bond yields are no longer driving up the dollar trend as before.

The Bloomberg US Treasury Index is heading towards a quarterly decline as investors sell off long-term treasury bonds amid concerns about the trajectory of US government debt. Meanwhile, Morgan Stanley Capital International (MSCI)'s Emerging Market Currency Benchmark Index is expected to record its biggest quarterly gain in more than a year.

The data showed that this drove the correlation between the two to the highest level of negative correlation since the first quarter of 2022.

Developing countries have attracted global capital flows this year as investors seek higher yields and diversify their portfolios from dollar-denominated assets. Normally, rising US bond yields weaken this appeal, but since the reason US bonds are under pressure is not due to the hawkish stance of the Federal Reserve, this traditional relationship has broken down.

Investors increasingly expect the US government to address its debt and deficit burdens through inflationary and easing policies (such as bond repurchases), which will weaken the real value of the dollar.

The depreciation of the dollar made it cheaper for countries denominated in other currencies to buy commodities, thereby boosting demand for commodities. Commodity export-oriented emerging markets, including South Africa, Colombia, and Chile, saw the biggest currency gains this month.

Nick Rees, head of macro research at Monex Europe, said that dollar depreciation transactions make emerging markets more attractive than developed markets, and also make commodities more attractive than stocks or bonds.

Rees said, “If concerns about the depreciation of the US dollar continue to rise, then in addition to breaking away from the Group of Ten (G10) currency or moving away specifically from the rotation of the US dollar, this is also a constructive environment for a wider range of commodity currencies.”