Looking beyond immediate events, the biggest structural imbalance in the global economy remains the US current account deficit – the US has been living beyond its means, financed by emerging markets savings, for the best part of a decade. Should this change then the dollar will have to fall against emerging currencies. Local currency debt is one of the best, if not the best, hedges against structural dollar weakness. Should developed world turmoil worsen, dollar weakness is the top feature of the most bearish global scenarios. Investors wanting to insure against this risk should allocate to emerging local currency debt.

There has been little significant increase of default risk for emerging market sovereign issuers. While there are some vulnerabilities in eastern Europe, banking sectors and corporate balance sheets are remarkably strong across Latin America and Asia. Stronger productivity growth in emerging markets should provide significant support for currency appreciation over the medium-term.

This is in contrast to much more inadequately priced developed country sovereign risks. Support for the dollar depends on the rest of the world, and central banks in particular, remaining content to finance the US current account deficit. The risk is that this willingness changes suddenly.