As the US dollar slides to a four-year low, global capital markets are undergoing a dramatic asset repricing and allocation shift, with investors accelerating the diversification of funds from US assets to other regions worldwide, driving a comprehensive breakout for emerging market stocks, bonds, and currencies at the start of 2026.
The MSCI Emerging Markets Index has surged nearly 11% in January, marking its best performance since 2017 following a 31% surge in 2025. This powerful rally has boosted the market capitalization of the index's constituents by over $1 trillion this year, pushing the total market value to $28 trillion. In contrast, developed markets have shown more moderate performance, with the MSCI World Index rising just 2.8% this year and the S&P 500 gaining 1.6%.
In this asset rotation, Colombian and South Korean stock markets, measured in US dollar terms, have led global markets with gains exceeding 20%. Concurrently, stock markets in Turkey, Brazil, South Africa, Chile, Mexico, and Taiwan have also posted gains of at least 10% this month. This uptrend is fueled by robust currency rebounds, soaring commodity prices, and investors shifting their artificial intelligence bets from the United States to Asian chip manufacturers.
The rally extends beyond equities, reflecting a structural change in fund flows. The latest flow data indicates global investors are actively buying emerging market local currency bonds, seemingly undeterred by concerns that a recent yen rebound could trigger an unwinding of carry trades. Market analysis suggests that as the dollar cycle reverses, the fundamental improvements in emerging markets and enhanced central bank credibility, previously obscured by the Federal Reserve's high-interest-rate policy, are beginning to deliver tangible returns for investors.
The retreat of the strong dollar is revealing underlying resilience. For a long time, the strength of the US dollar largely masked the fundamental improvements within emerging markets. David Hauner, Head of Global Emerging Market Fixed Income Strategy at Bank of America, pointed out that the fundamental improvement in emerging markets has been ongoing for some time, but it wasn't until the dollar weakened that global investors truly began to pay attention to this change.
Over the past few years, many emerging market central banks, aiming to retain capital and combat inflation, raised interest rates significantly above inflation levels. As the dollar's prolonged strength since 2022 comes to an end, these policies are beginning to show their effectiveness. James Lord, Head of Global FX and Emerging Market Strategy at Morgan Stanley, stated that with the turning of the dollar cycle, emerging market central bank governors are reaping the rewards of their "enhanced credibility."
Performance in the foreign exchange market corroborates this view. The Brazilian real, Mexican peso, Chilean peso, and South African rand have emerged as the best-performing major currencies this year; when including the returns from these countries' relatively high interest rates, their gains against the US dollar reach 5% to 6%.
Soaring chip and commodity prices are further fueling the rally. Beyond the looser macro monetary environment, explosive growth in specific sectors is a key driver of this market trend. Archie Hart, Equity Portfolio Manager at Ninety One, noted that if one observes the price trends of gold, silver, and memory chips, they appear to be rising almost "vertically." Since last October, spot prices for some memory chips have nearly quadrupled due to supply shortages driven by AI demand.
This demand directly benefits Asian markets, which are critical links in the global supply chain. Chip manufacturer stocks in Taiwan and South Korea recorded significant gains earlier this year; these firms are key suppliers to US AI companies and now hold substantial weight in emerging market benchmark indices. Furthermore, the MSCI South Africa Blue Chip Index (primarily composed of mining and banking stocks) has risen 15% this year, reaching a record high.
Edward Evans, Emerging Markets Equity Portfolio Manager at Ashmore Group, added that the momentum driving the stock market rally stems not only from the AI boom and a weak dollar. He believes that companies in many developing markets, such as fintech and e-commerce groups in Latin America, are themselves globally competitive "market leaders."
Large-scale capital is shifting from US stocks to emerging markets. Position adjustments by institutional investors reveal a clear trend of "de-Americanization" and diversification. A recent Bank of America analysis of global "long-only" funds managing trillions of dollars in assets found that these funds sold $160 billion worth of US stocks last year, while simultaneously buying $109 billion of stocks in Asian markets excluding Japan and $59 billion of stocks in other emerging markets.
Alper Gocer, Head of Emerging Market Debt at Pictet Asset Management, stated that investors are not panicking and fleeing the dollar but are seeking new capital allocation options. He noted that as investors begin seeking diversification, emerging markets, particularly local currency debt, have become one of the high-quality alternative solutions.
Bonds and currencies show strong performance, unfazed by carry trade risks. In the fixed income space, emerging market assets have also outperformed their developed market counterparts. The J.P. Morgan Emerging Markets Local Currency Bond Index has risen over 2% year-to-date, following a 19% return in 2025. In comparison, the competing US high-yield bond pool gained less than 1% this month.
Notably, this rebound has proceeded unaffected by warnings about potential yen intervention. Despite recent reports suggesting the US might coordinate with Japan to intervene in the currency market, which pushed the yen nearly 3% higher against the dollar, this has not triggered a broad unwinding of "carry trades" that would spill over to emerging market assets, as it has in the past.
Barclays analysts pointed out that there has been no instance this year of emerging market assets suffering due to the unwinding of yen short positions. Instead, a "confidence shock" regarding the dollar is triggering a strategic catch-up allocation to emerging market local currency assets, which had long lagged. Data from fund flow monitor EPFR shows investors added $1.5 billion to emerging market local currency bond funds last week, the largest weekly increase since 2018. Morgan Stanley's James Lord emphasized that this is not merely hedge fund speculation in short-term forex markets, but genuine purchases of emerging market local currency bonds evident in official balance of payments data.
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