Hidden GEMs: A turn in the US dollar cycle and what it means for emerging market debt

For EM debt investors, a weaker dollar could mark a long-awaited shift from headwind to tailwind

After more than a decade of US dollar dominance, signs are emerging that the currency’s extraordinary rally may finally be peaking. A combination of structural imbalances and shifting political priorities in Washington is setting the stage for a potential greenback depreciation. In the paper, Tipping point: A turn in the in the US dollar cycle and what it means for emerging market debt, Grant Webster, Co-Head of Emerging Market Sovereign & FX, explores the dollar’s extended rally and what a correction could mean for global investors, particularly in emerging market debt.

Grant Webster, Co-Head of EM Sovereign & FX, Ninety One: “We’ve long believed that the US’s large twin deficits and asset overvaluation would eventually act as gravitational forces on the dollar.  Now, with signs that US policymakers are prioritising competitiveness of the US economy, a weaker dollar appears increasingly likely.”

The strong dollar has been a dominant driver of asset-class returns

Over the past 50 years, the US dollar has moved through three major cycles. Since the current cycle began in 2011, it has gained more than 40% on a trade-weighted basis – rising from undervalued levels during the Euro crisis to historically high valuations. This surge boosted unhedged returns for foreign investors in US assets but proved a major headwind for emerging market (EM) debt. “The post-2011 cycle has been painful for EM investors,” Webster noted. “As the dollar rose, it suppressed returns across the asset class, which had previously thrived during dollar weakness.”

Just how overvalued has the dollar become?

Much like past periods of extended dollar strength, the greenback’s continued rise has contributed to global imbalances – most notably a sharp decline in US manufacturing competitiveness. This came into focus in President Trump’s first term and now appears to be reaching a tipping point.

One simple way to illustrate the imbalance is by comparing GDP in nominal US dollars with GDP measured in purchasing power parity (PPP) terms. The PPP measurement adjusts for differences in the cost of living between countries, and this adjustment accounts for relative currency valuations. While the GDP of the United States is roughly $30 trillion in both measures, China’s GDP jumps from $20 trillion in dollar terms to $40 trillion in PPP terms. China can produce goods and make investments at half the cost of the United States. India appears even more divergent, with PPP-based GDP four times higher than GDP in dollar terms.

Webster said: “China’s GDP is around twice as large in PPP terms than in US dollars. In other words, in China it costs half as much to produce goods and services, build infrastructure and invest in people as it does in the US. Across emerging markets, PPP-based GDP is 2.4 times higher on average than dollar-based GDP, underscoring just how far out of line valuations have become. But even across developed markets outside of the United States, the divergence has grown considerably: 15 years ago, among developed markets including Germany and Japan, the United States was one of the cheapest places to produce goods; today, it is one of the most expensive.”

While structural drivers such as productivity and industrial policy also affect relative costs, the dollar’s strength remains a very significant contributor to the widening competitiveness gap between the United States and the rest of the world.

Have we reached a tipping point?

Tracking the ratio of PPP-based to US dollar-based GDP shows that current levels are at historic extremes – similar to conditions preceding the 2001 correction and the 1985 Plaza Accord.

“The ratios today mirror past dollar peaks. History tells us that when these gaps get this wide, a reversal tends to follow,” said Webster.

How much might the dollar weaken and what does that mean for economies?

While a stronger dollar has strained smaller emerging markets with dollar-denominated debt, it has also boosted exports from larger EM economies by making their production more competitive. Even developed regions like Europe saw manufacturing benefit as the dollar outpaced nearly all major currencies.

Today, however, a growing consensus suggests that the US administration may welcome a weaker dollar to restore lost competitiveness. A 20–30% depreciation over time could help rebalance trade dynamics without triggering global instability – and would be broadly positive for emerging markets. “Such a move would be manageable for large emerging markets and even beneficial for smaller, more indebted economies,” Webster said.

Implications for investors in EM debt

For EM debt investors, a weaker dollar could mark a long-awaited shift from headwind to tailwind. Since 2011, local currency bonds have delivered just 0.9%^[1] annually, with returns eroded by dollar strength. Now, with yields above 6%^[2], even a modest dollar decline could offer meaningful upside.

“EM debt has been under pressure for over a decade,” said Webster. “But the tide may be turning. Investors stand to benefit from both income and potential currency appreciation.”

Conclusion

The US dollar has appreciated by over 40% since 2011, reaching valuation extremes that have led to global imbalances and a loss of US manufacturing competitiveness. Purchasing power parity (PPP) comparisons highlight the dollar’s overvaluation, with GDP in emerging markets on average 2.4-times higher in PPP terms than in US dollar terms, and much higher than they were in 2011. The current divergence in PPP GDP versus US dollar GDP’s mirrors past US dollar peaks that preceded sharp corrections, such as the early 2000s and the 1985 Plaza Accord. Webster concluded: “A tipping point in the US dollar cycle seems upon us. A 20–30% dollar decline would likely restore US competitiveness against other developed markets and serve as a major tailwind for EM debt, particularly local currency bonds, which have underperformed during the dollar’s extended rally.”