With 2022 well over halfway through, markets may be feeling like the COVID-19 theme has subsided after the two-year peaks and troughs of the pandemic. But as always, new challenges arise and lead the way for more potential volatility.

Inflation is the ‘flavor of the year’ as economies swing into the aftermath of the pandemic, with central banks tightening monetary policy to manage dips in their own currencies and curb the rise in inflation. This theme is particularly challenging for emerging market economies. So too is the increasingly stronger U.S. dollar. All previous emerging market fallouts were linked to dollar strength, and as the need to steer off dips in currencies occurs, central banks have turned to tightening their monetary policies. This has led the World Bank to forecast just a 4.6% expansion for emerging economies this year, compared with an earlier 6.3% prediction. Meanwhile, the International Monetary Fund expects inflation to average 9.5% in emerging markets this year, or around 3.6% higher than projected in January.

First, a strong dollar often starts to depress global trade growth, as it is the “invoicing” currency of the world and holds the most purchasing power. This means that when the dollar appreciates, other currencies essentially depreciate, making the world poorer and less able to engage in trade. It also makes countries that have dollar-denominated debt less creditworthy, as it makes it harder for them to purchase the U.S. currency to manage their debts. Furthermore, it is likely less favorable for China. This can lead to an obstructive knock-on effect for emerging market countries due to their linked supply chains and commodities demand. Finally, the stronger dollar is also more likely to cause inflationary upward pressures for emerging markets because they typically purchase their raw materials in U.S. dollars.

The other complication for emerging markets is the simultaneous rise in commodity prices, which are likely to persist for some time given the current economic landscape. Emerging markets are experiencing the lagged effects of higher oil prices, elevated food prices, and higher import prices from currency depreciations. As the demand for products increases, so does demand for the materials used to produce them, which results in higher commodity prices. Commodities are also heavily related to demand and supply dynamics and, compared to other inflation protection assets like TIPS (Treasury Inflation Protected Securities), they tend to offer higher returns.

Rising commodity prices tend to hurt emerging markets, but others stand to benefit. Commodities are a critical source of exports and revenues for many emerging economies, and more than half of the world’s poor resides in commodity exporting countries. The reliance on commodities is particularly high for oil exporters such as Brazil, Mexico and Russia, and on metal and agricultural exporters such as South Africa and Chile.

Commodity prices undergo repeating cycles, and on average, from peak to peak, cycles last almost six years. For industry-intensive commodities, such as copper and aluminum, prices remain in the same phase of the cycle for 80% of the time. According to the World Bank Group’s Flagship Report from January 2022, this synchronization was reflected statistically in a common factor that, on average, accounted for roughly 15-25% of price variability for energy and metals, but only 2-10% of price variability for agricultural commodities and fertilizers.