U.S. dollar weakness is good news for emerging markets

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One of the biggest market trends of 2013 has almost completely unwound, as the U.S. dollar ended a period of remarkable strength and declined sharply for the fifth straight day Thursday. The most likely explanation for the reversal comes as good news for Canadian investors: economic growth in emerging markets is returning.

The U.S. trade-weighted dollar index has fallen 4.5 per cent from its 2013 peak of 84.6 on July 9. Thursday's decline was accompanied by strong moves higher by the two of the most beleaguered emerging markets currencies, the Indian rupee and Brazilian real.

Mark Dow, a former hedge fund manager and economist with the U.S. Treasury Department and International Monetary Fund, believes the big intraday move in the Brazilian real is an indication that currency traders were changing course by covering their short positions in Brazil.

In China, the yuan is pegged to the U.S. dollar (sort of), but I imagine the stronger-than-expected economic data out of Beijing Thursday played a big role in global currency action through the day. The long U.S. dollar, short emerging markets trade that was popular in the first half of 2013 is being removed, as we begin to see more signs of economic growth in the BRIC countries.

This chart shows the progress of the trade-weighted greenback against the Citi Economic Surprise Index for the emerging markets. It's not a perfect inverse relationship, but over the past three years the dollar has tended to move lower when emerging market data surprised to the upside. The surprise index remains in negative territory, but the upward trend since June implies that economic activity levels have bottomed. It also might explain the recent slide in the U.S. currency.

It's too early to make a definitive "off to the races" call for emerging market economies. But even signs that the short positions are being removed will be welcome for Canadian investors awaiting an upswing in developing-world commodity demand.

Scott Barlow is a contributor to ROB Insight, the business commentary service available to Globe Unlimited subscribers. Click here to read more of his Insights, and follow Scott on Twitter at @SBarlow_ROB.