ZE Market Watch: Oil, Dollar Strength and the Return of Emerging Market Volatility

By Chinedu Okoye 

Market Snapshot:

The past week has seen emerging market currencies weaken against the U.S. dollar as geopolitical tensions intensified across the Middle East. Risk-sensitive assets have retreated, with the MSCI Emerging Market Currency Index closing mid-week in negative territory, reversing part of the rally seen over the past several months.

At the same time, global markets have witnessed an unusual alignment of asset price movements: the U.S. dollar strengthened, gold prices firmed as investors sought safe havens, and BRENT crude rose toward the $80–$83 range

This coordinated movement across currencies, commodities and safe-haven assets is seen as a risk-off repositioning in global markets rather than a fundamental deterioration in emerging market economic conditions.

The Macro Catalyst:

The current volatility is largely driven by geopolitical risk premiums entering energy markets. Ad, historically, geopolitical conflicts involving key oil-producing regions tend to trigger rapid repricing in commodities as markets look to account for potential supply disruptions.

The Middle East remains central to global energy flows, with critical shipping routes such as the Strait of Hormuz handling roughly one-fifth of global petroleum trade (International Energy Agency; U.S. Energy Information Administration).

So, as tensions escalated, traders simply priced in the possibility of supply interruptions, pushing crude prices higher, this is not a case of higher organic demand but possibly lower available supply.

Brent crude (widely considered the international benchmark for seaborne oil trade and hence Middle Eastern Oil) has risen above $80 per barrel. The fact that Brent continues to trade at a premium to WTI validates the ZE view above on its greater sensitivity to global supply risks and international trade disruptions (Reuters Energy Markets; MSCI Commodities Research).

Coordinated Asset Moves: Dollar, Gold and Oil

The simultaneous rise of the U.S. dollar, gold, and oil is relatively uncommon under normal market conditions, this is because, commodity prices typically move inversely to the dollar due to currency pricing effects. However, during periods of geopolitical stress this relationship can temporarily break down.

The simultaneous move in these asset classes is as a result of three forces at play:

1. Safe-haven demand for the U.S. dollar due to its global reserve currency status.

2. Investor hedging through gold, historically used as a store of value during geopolitical uncertainty.

3. Energy supply risk premiums, pushing oil prices higher.

This is not too dissimilar from past conflicts that produced major geopolitical shocks,like the 1990 Gulf War and the early stages of the Russia-Ukraine conflict in 2022, where oil and gold rallied alongside a strengthening dollar (IMF Global Financial Stability Report; BIS market stress studies).

Implications for Emerging Markets

Emerging markets are particularly sensitive to this type of macro environment. Three transmission channels explain the pressure on emerging market currencies:dollar strength, energy import exposure, and carry trade vulnerability.

1. Dollar Strength: When global risk aversion rises, capital typically flows toward U.S. assets. This increases demand for the dollar and weakens emerging market currencies.

2. Energy Import Exposure: Many emerging economies (including India, Turkey and several Southeast Asian nations) are net importers of crude oil. Hence, higher oil prices could worsen their trade balances and increase pressure on their currencies.

3. Carry Trade Vulnerability: Over the past nine months, investors have heavily allocated capital to emerging market local-currency bonds, attracted by relatively high interest rates compared with developed markets.

But a continuous, dollar strength and rate cut slash has and could raise volatility further, as investors often unwind these carry trades to avoid foreign exchange losses.

According to Bloimberg market reports, central banks in Indonesia, Turkey and India have already intervened in FX markets to prevent excessive depreciation in their currencies (Bloomberg; regional central bank communications).

Policy Complications:

Another factor confronting EM contributing to volatility is the repricing of global interest-rate expectations. Markets had previously anticipated faster monetary easing from major central banks, most importantly the US Federal Reserve. However, higher energy prices if lingered for too long could introduce renewed inflation risks.

Energy price shocks often transmit quickly into broader inflation through: transportation costs, electricity prices, and manufacturing inputs. So, if oil prices remain elevated, central banks may be forced to maintain tighter monetary conditions for longer, delaying the rate cuts markets had priced earlier in the year.

Scenario modelling by MSCI suggests that sustained energy supply disruptions could push Brent crude toward the $100 per barrel range, creating stagflationary pressures across several economies (See MSCI Macro Scenario Analysis).

ZE Analytical Remarks

In ZE’s view, the recent volatility reflects trader positioning and geopolitical risk repricing rather than a structural breakdown in emerging market fundamentals.

Markets have historically reacted sharply to geopolitical escalations before stabilizing once diplomatic channels reopen. The early months of the Russia-Ukraine conflict offer a precedent, cause commodities initially surged before settling into a new level.

Nevertheless, the current environment does introduce risks for certain asset classes, and emerging market local-currency assets (bonds, cash and near cash instruments)remain vulnerable if the dollar rally continues.

Conversely, currency weakness may create valuation opportunities in emerging market equities, as foreign investors gain exposure to assets trading at discounted prices in dollar terms.

Sectoral Implications:

In periods characterized by rising commodity prices and geopolitical uncertainty, sector performance tends to diverge significantly.

Sectors that are relatively insulated include: energy, utilities, and consumer staples. Energy producers benefit directly from higher commodity prices, while utilities and staples tend to maintain stable demand regardless of economic volatility.

More vulnerable sectors include: technology [hardware] telecommunications, financial services, and consumer discretionary. These industries tend to be more capital-intensive and leverage-sensitive, making them susceptible to rising financing costs and currency volatility.

Strategic Positioning

For institutional investors, the current environment suggests a more defensive portfolio posture.

Gradual positioning toward defensive sector (particularly energy, utilities and consumer staples) may offer stability during periods of macro volatility.

Investors with sufficient liquidity can also deploy phased capital allocation strategies, allowing them to accumulate assets during market dislocations while mitigating timing risk. It is also very likely, that exchange-rate hedging strategies may become increasingly relevant for investors maintaining exposure to emerging markets.

ZE Concluding Remarks:

• The current selloff in emerging market currencies reflects the re-pricing of geopolitical risk rather than a collapse in macro fundamentals.

• If tensions de-escalate, markets could stabilize quickly.

• However, if energy supply disruptions intensify, the world may face a renewed commodity-driven inflation cycle, with far-reaching implications for monetary policy, capital flows and global asset allocation.

• Commodity rich economies are expected to be the least hit and the quickest to recover in the EM and FM Space.

• ZE is overweight value stocks, and defensive assets in addition to EM ETFs and Nigerian Treasury Bills.