A surging US dollar could send shockwaves from Argentina into other emerging markets

Argentina is spiraling into a crisis, with a sinking currency and potential bailout from the IMF.Some fear that other emerging markets could follow, with the dollar rally adding further pressure.Brazil is the most vulnerable.Months after Buenos Aires defaulted on the largest amount of debt in history in 2001, Brazil's economy took a turn for the worst. As Argentina finds itself in a similar economic storm, some fear financial contagion could spill over into emerging markets once again.TheArgentine pesohas shed more than 30% versus the dollar this year, prompting the country to hike interest rates to 40% and reach for a controversial bailout by the IMF this month. While contagion risk is currently "contained," according a group of Citi Research analysts led by David Lubin, the rising US dollar could change that."If broad sentiment in EM turns or the situation in Argentina deteriorates, the pressure to increase portfolio liquidity may lead to contagion to other EM countries," Lubin said. "Further dollar appreciation might be the most likely trigger for this risk to materialize."Expectations for faster global growth and an aggressive central bank have pushed thedollar higher in recent months, lifting it nearly 5% on the US dollar index since mid-February. Likewise, US bond yields have been climbing, with the closely-watched 10-year Treasury yield soaring to its highest level since 2011 last week at 3.12%.David Duonga senior FX strategist at HSBC who specializes in Latin Americasaid that while the situation in Argentina is currently "contained," these factors could be adding up to "a recipe for greater risk aversion regionally.""There is a concern that markets will not discriminate between Argentina and the other LatAm countries as nervousness dominates the performance for the region as a whole," Duong said."Whats more relevant for LatAm FX performance is a sustained rise in US yields and the USD."Brazil is among the most vulnerable to Argentina contagion, according to analysts, since the two countries tend to have a correlated business cycles.A currency crisis in Brazil right before the millennium actually set the stage for Argentina's 2001 depression, they said, which in turn helped to undermine the stability of Brazilian asset prices in 2002."The two neighbors seem to have a track record of transmitting shock to each other in a ping-pong-like fashion," according to Lubin.Argentina is Brazil's third-largest trading partner and accounts for 66% of the country's auto exports.Still, contagion effects this time around could be "marginal," Lubin said. Citi Research estimates a marginal elasticity of 0.02 in Brazils GDP growth rate to a reduction of 1% in Argentinas.SEE ALSO:'Everything' in Argentina is 20% to 30% overvalued and a crisis is on the way, according to an economistJoin the conversation about this storyNOW WATCH: Why so many fast food logos are red
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