The weakening of the US dollar triggers a "major portfolio rebalancing": emerging markets surge 11%, market capitalization increases by one trillion, and stock markets in multiple countries rise over 20%.

The weakening of the US dollar triggers a "major portfolio rebalancing": emerging markets surge 11%, market capitalization increases by one trillion, and stock markets in multiple countries rise over 20%.

As the US dollar falls to a four-year low, global capital markets are undergoing a dramatic asset repricing and allocation shift. Investors are accelerating the diversification of funds from US assets to other regions of the world, driving a broad surge in emerging market stocks, bonds, and currencies at the start of 2026.

The MSCI Emerging Markets Equity Index surged nearly 11% in January, marking its best performance since 2017 after a 31% jump in 2025. This strong rally boosted the market value of the index’s constituents by over $1 trillion this year, bringing the total market capitalization to $28 trillion. In comparison, developed markets were more subdued, with the MSCI World Index rising just 2.8% and the S&P 500 up 1.6%.

In this rotation, the stock markets of Colombia and South Korea have led the world with dollar-denominated gains exceeding 20%. Meanwhile, the stock markets of Turkey, Brazil, South Africa, Chile, Mexico, and Taiwan all rose by at least 10% this month.This surge has benefited from a strong rebound in currency exchange rates, soaring commodity prices, and investors shifting AI bets from the US to Asian chip makers.

The rise is not limited to equities; it also reflects a structural change in capital flows. The latest data show global investors are actively buying local currency bonds in emerging markets, undeterred by worries that the recent yen rebound might trigger carry trade unwinding. Market analysis suggests that with the reversal of the dollar cycle, improvements in the fundamentals and central bank credibility of emerging markets—previously masked by the Fed’s high-rate policy—are starting to bring tangible returns for investors.

The Retreat of the Strong Dollar Reveals Fundamental Resilience

For a long time, the strength of the US dollar has largely masked improvements in emerging market fundamentals. David Hauner, Chief of Global Emerging Market Fixed Income Strategy at Bank of America, points out that fundamental improvements in emerging markets have lasted for some time, but only now, with the dollar weakening, are global investors really paying attention.

Over the past few years, many emerging market central banks raised interest rates sharply above inflation levels to retain capital and fight inflation. With the long run of dollar strength since 2022 coming to an end, these policies are beginning to show results. James Lord, Morgan Stanley's Global FX and Emerging Markets Strategy Chief, states that with the dollar cycle turning, emerging market central bankers are now reaping the rewards of their “enhanced credibility.”

Exchange rate market performance confirms this. The Brazilian real, Mexican peso, Chilean peso, and South African rand are among the best-performing major currencies this year; including these countries’ relatively high interest rate returns, their gains against the dollar reach 5% to 6%.

Chip and Commodity Price Surges Propel the Rally

Besides loose macro-currency conditions, sector-specific booms have also powered the current rally. Archie Hart, equity portfolio manager at Ninety One, notes that if you look at the price trends of gold, silver, and storage chips, you’ll see nearly “vertical rises.” Since October last year, spot prices of some storage chips have nearly quadrupled due to AI-driven demand and supply shortages.

This demand directly benefits Asian markets, key nodes of the global supply chain. Taiwanese and South Korean chip makers saw significant stock gains earlier this year; these firms are key suppliers to US AI companies and now constitute a large share of the emerging market benchmark index. Moreover, the MSCI South Africa Blue Chip Index (mainly mining and banking stocks) is up 15% this year, reaching an all-time high.

Edward Evans, emerging market equity portfolio manager at Ashmore Group, adds that the rally’s momentum is not just from AI fever and dollar weakness. He believes many developing market companies, such as fintech and e-commerce groups in Latin America, are globally competitive “market leaders.”

Massive Fund Shift from US Equities to Emerging Markets

Institutional investors’ portfolio adjustments show a clear trend of “de-US-equitization” and diversification. Bank of America's recent analysis of global “long-only” funds managing trillions of dollars finds these funds sold $160 billion of US equities last year, while buying $109 billion of non-Japan Asian equities and $59 billion of other emerging market stocks.

Alper Gocer, Head of Emerging Market Debt at Pictet Asset Management, says investors are not fleeing the dollar in panic but seeking new capital allocation options. He notes that investors are diversifying, with emerging markets—especially local-currency debt—becoming one of the premium alternatives.

Bonds and Currencies Outperform, Unfazed by Carry Trade Risks

In fixed income, emerging market assets have also outperformed developed market peers. The JPMorgan Emerging Markets Local Currency Bond Index returned 19% in 2025 and has already risen over 2% this year. By contrast, US high-yield bonds—competing for the same capital pool—are up less than 1% this month.

Notably, this rebound has not been affected by warnings of yen intervention. Despite reports that the US may coordinate with Japan to intervene in the FX market, causing the yen to rise nearly 3% against the dollar, this did not trigger the broad “carry trade” unwinding that previously affected emerging market assets.

Barclays analysts note that there has been no damage to emerging market assets this year from yen short covering. Instead, a “confidence shock” in the dollar is triggering strategic reallocations to long-neglected emerging market local currency assets. EPFR data show investors poured $1.5 billion into emerging market local currency bond funds last week—the largest single-week inflow since 2018. Morgan Stanley’s James Lord emphasizes that this is not just hedge funds’ short-term FX carry trades, but real buying of emerging market local currency bonds visible in official international balance of payments data.

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