Dollar Strength Takes Toll on Emerging Market Currencies

The Federal Reserve has raised interest rates for the first time this year, and it's already affecting emerging market currencies. U.S. dollar strength is building in these cycles because a rising policy rate lifts the return on dollar assets relative to everything competing with them.

Capital that had been parked in higher-yielding emerging market currencies starts to find the dollar a more reasonable place to sit, according to Julian Pineda, Market Analyst at StoneX Media. The Mexican peso holds the widest interest rate advantage in North America, but its durability now depends less on Mexico and more on what happens to U.S. yields.

The difference between Mexican and U.S. interest rates is still important, but it could become less attractive if U.S. rates and bond yields continue to rise, Pineda says. The Bank of Mexico appears to be waiting for further economic data before making new decisions, leaving the gap exposed to movement on the U.S. side alone.