Emerging-market (EM) stocks held their ground on Monday, but the recent rally took a breather as a stronger US dollar weighed on local currencies. The pause comes as investors shift their focus to upcoming corporate earnings to gauge whether the momentum can be sustained.
The MSCI EM currency gauge fell 0.2% as the dollar index rebounded from two-week lows. Among the hardest hit were Turkey's lira, which slipped 0.1%, and Hungary's forint, which also edged lower. The moves reflect a familiar dynamic: when the dollar strengthens, EM currencies tend to weaken, making dollar-denominated debt more expensive and reducing the appeal of EM assets for foreign investors.
What's behind the pause?
Sentiment got a boost from two developments last week. First, oil prices dipped about 1% after OPEC+ agreed to lift output targets starting in August. Lower oil prices are generally positive for EM economies that are net importers of crude, such as India and Turkey. Second, a softer-than-expected US jobs report cooled expectations for another Federal Reserve rate hike, which had been weighing on risk appetite.
However, those tailwinds were not enough to sustain the rally. The dollar's rebound, driven by safe-haven demand and uncertainty about the global economic outlook, has put pressure on EM currencies. For investors, this creates a tricky environment: EM stocks may look cheap, but currency depreciation can quickly erode returns when measured in dollar terms.
The recent strength in some EM markets had been fueled by hopes that the Fed was done raising rates. But the jobs report, while softer, still showed a resilient labor market, leaving the door open for further tightening if inflation proves sticky. That uncertainty is keeping many investors on the sidelines.
Earnings season in focus
With the macro picture mixed, attention is turning to corporate earnings. Companies across emerging markets are set to report second-quarter results in the coming weeks, and investors will be watching closely for signs that the rally has fundamental support.
In China, the world's largest EM, earnings from tech and consumer companies will be particularly important. The country's economic recovery has been uneven, and weak consumer spending has weighed on profits. Meanwhile, China and Hong Kong stocks rose recently as an AI rally broadened and regulators eased refinancing rules, but the sustainability of that move depends on earnings delivering.
In India, bank stocks have been a bright spot, with strong loan growth driving gains. But rising deposit costs are a concern, and earnings will show whether banks can maintain their margins. Indian bank stocks rallied on the back of robust lending, but the cost of funding is a key risk to watch.
In South Africa, the rand and the JSE stock index rallied last week after the weak US jobs data weighed on the dollar. But the currency remains volatile, and earnings from mining and financial companies will be closely watched for clues on the health of the economy. South African assets got a boost from the dollar's dip, but the rally may be short-lived if the greenback strengthens again.
What it means for investors
For everyday investors, the key takeaway is that EM assets are being pulled in two directions. On one hand, lower oil prices and a less hawkish Fed are supportive. On the other, a stronger dollar and uncertainty about earnings create headwinds.
Currency risk is a major factor in EM investing. Even if local stock prices rise, a weakening currency can reduce or even eliminate gains when converted back to dollars. Investors should be aware of this and consider hedging strategies if they have exposure to EM currencies.
The earnings season will be critical. If companies report strong profits and give optimistic guidance, it could reignite the rally. But if earnings disappoint, the pause could turn into a pullback. Investors should watch for results from major EM companies in sectors like technology, banking, and energy.
In the near term, the dollar's direction will be a key driver. If the Fed signals that it is done raising rates, the dollar could weaken, providing a tailwind for EM assets. But if inflation remains stubborn and the Fed is forced to hike again, the dollar could strengthen further, putting more pressure on EM currencies and stocks.
Overall, the EM rally is at a critical juncture. The next few weeks of earnings will determine whether it has legs or whether the pause turns into a more significant correction. For now, investors are in a wait-and-see mode, watching both corporate results and central bank signals.
