Can the weak-dollar tailwind for emerging markets last?

In partnership with

Contrary to so many expectations at the beginning of the year, emerging market assets have performed well under Donald Trump’s second presidential term so far. Much of that outperformance is due to a weaker USD, as a result of investors reconsidering the safe-haven status of U.S. Treasury bonds and their large positions in U.S. assets.

Before the new administration came into office, markets were expecting a strong dollar and were bullish on ongoing U.S. economic exceptionalism and outperformance. In its Asset Management Outlook for 2025, Goldman Sachs analysts explained this consensus view:

As we now know, tariffs have featured prominently in the White House’s agenda, but even more so than the team at Goldman seemed to be expecting. Yet the real surprise is the market reaction to the tariffs. The normal negative USD-global risk sentiment correlation reversed well ahead of Trump’s April 2nd “Liberation Day” blockbuster tariff announcement. Instead of global investors flocking to the safety of U.S. Treasuries amid heightened risk sentiment, which pushes their value and that of the dollar higher, for much of March and April the USD and Treasuries fell alongside equity market declines.

While I can’t claim to have foreseen the breakdown in that long-standing safe haven quality of the dollar and U.S. Treasuries, in my last post of 2024, I did note the dissonance between increasing U.S.-focused global capital market unipolarity, on the one hand, and rising geoeconomic multipolarity, on the other. Add to that ever-louder voices over the past 3-4 years questioning the dollar’s reserve currency status and with U.S. budget deficits routinely at 6% of GDP, it should come as no shock that markets increasingly perceive U.S. sovereign risk to be rising.

In this context, institutional investors are considering how to adjust their high allocations to U.S. assets. Rather than rotating into Treasuries amid equity market volatility as in many previous years, many seem to be buying into international markets instead. This explains the parallel drops in the S&P500, Treasuries, and the USD this spring, as well as strong returns in European assets and emerging markets.

So, this year’s boom in EM asset returns isn’t only thanks to a weaker dollar that eases hard currency debt servicing and gives EM central banks more monetary policy space to cut rates. It is also due to capital flows out of the U.S., presumably some of which is ending up in EM. Moreover, the narrative around EM used to be that large debt loads were a concern. While this is still true, markets are increasingly worried about debt burdens in developed markets.

To be clear, the S&P500 has since rebounded from its early April sell-off to a reach a new record in recent days. That worrying positive correlation between the USD, Treasuries, and risk sentiment seems to have disappeared - for now. The greenback has continued to weaken in recent weeks, amid market expectations that inflation in the U.S. is moderating and the pricing in of a Fed rate cut in September.

Yet there is a substantial risk to this outlook. For one, U.S. tariff policies are inflationary for the U.S. and deflationary for China, Europe, and net exporters in general. This would be positive for U.S. rate differentials with other countries, which would strengthen the dollar. Then consider that China has been circumventing U.S. tariffs by shipping goods to Vietnam, Thailand, Malaysia, and Indonesia first, and that U.S. importers built up substantial inventories before tariffs had a chance to take effect. Taken together, these dynamics have delayed the impact on U.S. inflation.

Lastly, global Purchasing Manager Indices - which measure the output and/or input prices, charged to customers and paid to suppliers, respectively - serve as a leading indicator for inflation. The latest PMI readings suggest that tariff inflation is coming to the U.S., which could well cause the Fed to hold rates in September. As such, dollar strengthening is a key risk that EM investors will have to consider. For now, though, the weak USD tailwind is blowing in full force.

Disclaimer: The content provided in this newsletter is for informational purposes only and should not be construed as financial, investment, or other professional advice. While I strive to ensure accuracy, I make no guarantees regarding the completeness or reliability of the information presented. Readers are encouraged to conduct their own research and consult with qualified financial professionals before making any investment decisions. The author and publisher are not responsible for any actions taken based on the information provided.