In the past few monthlies we’ve warned that a strong dollar has the potential to cause emerging market crises. From a valuation standpoint, the dollar is very overvalued against almost all currencies, but rising interest rates and the appreciating momentum may drive it to become even more overvalued. If the current trend of dollar strength persists, it is very likely that we will see emerging market currency crises. This will lead to weaker stock markets and wider credit spreads.
The last time the JP Morgan US Nominal Broad Effective Exchange Rate was as strong as it is today, it triggered the Argentinian devaluation and default, the Brazilian devaluation and a Turkish devaluation. Many emerging market stock markets are already cheap. If currency crises were to happen, then investors will be looking at similarly compelling long-term buying opportunities as emerged in 2002 when stocks rose fourfold over the next six years.