Emerging market stocks experienced their strongest August since 2004, with a depreciating dollar driving capital flows.

Emerging market stocks are recording their best August performance in over two decades, boosted by a weaker dollar and the spread of the artificial intelligence boom. However, as the month draws to a close, escalating tensions in the Middle East and renewed expectations of a Federal Reserve rate hike have made market sentiment more cautious.

The MSCI Emerging Markets Equity Benchmark Index rose 3.3% in August, marking its largest gain for the same period since 2004. The continued rise in global investors' desire to diversify their exposure to dollar assets has driven capital inflows into emerging markets, a force that has simultaneously supported gold demand.

On Monday, the index fell slightly by 0.1%. Renewed tensions between the US and Iran, coupled with the lingering effects of Federal Reserve Chairman Warsh's speech in Jackson Hole last Friday, pushed the probability of a 25 basis point rate hike in September to over 60% in the money market, putting pressure on risk assets.

September will see a flurry of events – including non-farm payroll data, inflation data, and the Federal Reserve's interest rate decision. If the rate hike is implemented, it could offset the effects of dollar depreciation trades by pushing up the dollar and US Treasury yields, and weaken the attractiveness of risk assets.

The depreciation of the US dollar is the main driver of capital flows.

The core driver of this round of emerging market gains is market concerns about the US fiscal situation.

The so-called "dollar devaluation trade" refers to betting that the US government will allow the purchasing power of its currency to gradually erode in order to alleviate debt and deficit pressures. Hasnain Malik, head of emerging market equities and geopolitical strategy at Tellimer, said that this logic is substantially supporting the upside of emerging market assets.

"Concerns about U.S. fiscal policy and debt have prompted a new wave of capital inflows into emerging market local currency assets, including equities," Malik said. "Market sentiment toward AI technology leaders has stabilized, while a weaker dollar has boosted gold prices."

South Korean pension funds enter the market; Brazilian presidential election triggers stock market rally.

South Korean stocks bucked the trend and rebounded on Monday amid overall downward pressure, helping emerging market indices recover some lost ground.

Samsung Securities noted that South Korean pension funds are buying into the technology sector. SK Hynix and Samsung Electronics both closed up more than 1.2% on Monday, boosting market confidence.

Brazilian financial assets experienced significant volatility on Monday. Latest polls showed President Luiz Inácio Lula da Silva's lead in the October election had narrowed, causing the Brazilian real to rise as much as 0.6%, interest rate swaps to decline slightly, and the stock market to follow suit.

"Bolsonaro's momentum has picked up somewhat," said Alejandro Cuadrado, a strategist at BBVA in New York. "The final election result will be very close, but the resulting volatility in asset repricing could be quite significant."

Emerging market currencies recorded their second consecutive monthly gain

In terms of exchange rates, the emerging market currency index was almost flat on the last trading day of the month, but still recorded its second consecutive monthly increase and is on track for its best quarterly performance since June 2025.

The best-performing currencies this month include the South Korean won and the South African rand. The Polish zloty led the gains on Monday as higher-than-expected Polish inflation data reduced market bets on a rate cut in the country.

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