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By Jason Stipp and Robert Johnson, CFA | 01-29-2014 12:00 PM

EM Currency Crunch: What Does It Mean for U.S. Investors?

Emerging-markets policymakers should be able to stabilize their currencies, but some ripple effects will hit U.S. fundamentals, says Morningstar's Bob Johnson.

Jason Stipp: I'm Jason Stipp for Morningstar.

Emerging-markets currency volatility has been topping headlines in recent days and stoking memories of the late 1990s currency crisis.

Here to talk about what this means for U.S. investors and why is this happening, is Morningstar's Bob Johnson, our director of economic analysis.

Bob Johnson: Great to be here today.

Stipp: Let's talk about what's going on with emerging-markets currencies. There was news about Turkey recently; other countries have been in the news. What are the factors at work that are causing these problems with these currencies?

Johnson: The big headline news is that the U.S. Federal Reserve has begun tapering their bond purchases, and [those purchases] will probably come to an end by the end of the year. What's happened is that a lot of people, when rates were so low in the U.S., were investing in emerging markets and cash flowed into those markets that offered higher rates than the U.S.

Now, as the U.S. rates have come back up--the 10-year bond is up from 1.8% to 2.7%-2.8%, so a big change in interest rates--and there is more turmoil around the world, so there is kind of a flight to safety as well. People are pulling out of the emerging markets and buying U.S. bonds instead of emerging-markets bonds.

Stipp: What does that mean for those emerging-markets countries, if people are leaving their currency and coming to the U.S. currency?

Johnson: When they sell their bonds, then they translate that back into dollars. What that does is, it depresses the local currency because you are selling it, and it boosts the dollar because you are buying dollars. So, it begins to really have an effect on the currency. You mentioned Turkey. That was one where this has been an ongoing issue, and there are some other side issues--it's an election year and there is a corruption scandal going on Turkey right now. Their currency is down by about a third.

Stipp: What does that mean from an economic perspective, if your currency has lost a third of its value?

Johnson: The biggest impact is that things that you import into your country now cost about a third more than they used to.

Stipp: So, inflation…

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