The weakening of the US dollar triggers a "major repositioning": Emerging markets surge by 11%, with a market capitalization increase of $1 trillion, and stock markets in multiple countries rise by over 20%

As the US dollar slides to a four-year low, global capital markets are undergoing a dramatic asset repricing and reallocation shift, with investors accelerating the diversification of funds from US assets to other regions around the world, driving a comprehensive explosion in emerging market stocks, bonds, and currencies at the start of 2026.

The MSCI Emerging Markets Stock Index surged nearly 11% in January, marking its best performance since 2017 after a 31% increase in 2025. This strong upward trend has pushed the market capitalization of the index constituents to increase by over $1 trillion this year, reaching a total market value of $28 trillion. In contrast, the performance of developed markets appears more moderate, with the MSCI World Index rising only 2.8% this year, while the S&P 500 Index increased by 1.6%.

In this asset rotation, the stock markets of Colombia and South Korea have seen dollar-denominated gains exceeding 20%, leading the global market. Meanwhile, the stock markets of Turkey, Brazil, South Africa, Chile, Mexico, and Taiwan have also recorded gains of at least 10% this month. This surge is attributed to a strong rebound in currency exchange rates, soaring commodity prices, and investors shifting their bets in the artificial intelligence sector from the US to Asian chip manufacturers.

This increase is not limited to the stock market; it also reflects structural changes in capital flows. The latest data on capital flows shows that global investors are actively buying emerging market local currency bonds, undeterred by concerns over potential unwinding of arbitrage trades triggered by the recent rebound of the yen. Market analysis indicates that as the dollar cycle reverses, the previously masked improvements in emerging market fundamentals and enhanced central bank credibility are beginning to yield substantial returns for investors.

Strong Dollar Retreat Reveals Fundamental Resilience

For a long time, the strength of the dollar has largely obscured improvements in the internal fundamentals of emerging markets. David Hauner, head of global emerging markets fixed income strategy at Bank of America, pointed out that the improvement in emerging market fundamentals has been ongoing for some time, but it was not until the dollar weakened that global investors began to truly pay attention to this change.

In recent years, many emerging market central banks have significantly raised interest rates above inflation levels to retain capital and combat inflation. With the long-standing strength of the dollar since 2022 coming to an end, these policies are starting to take effect. James Lord, head of global foreign exchange and emerging markets strategy at Morgan Stanley, stated that as the dollar cycle turns, central bank governors in emerging markets are reaping the rewards of their "enhanced credibility."

The performance of the currency market corroborates this. The Brazilian real, Mexican peso, Chilean peso, and South African rand have become the best-performing major currencies this year, with their gains against the dollar reaching 5% to 6% when accounting for these countries' relatively high interest rate returns.

Surge in Chip and Commodity Prices Fuels the Rally

In addition to the easing macro monetary environment, the explosion in specific industries is also a key driving force behind this round of market rally. Archie Hart, a portfolio manager at Ninety One, pointed out that if one observes the price trends of gold, silver, and storage chips, they almost exhibit a "vertical rise" pattern. Since October of last year, due to AI demand leading to supply shortages, the spot prices of some storage chips have nearly quadrupled This demand directly benefits the Asian market, which is a key link in the global supply chain. Chip manufacturers in Taiwan and South Korea recorded significant gains earlier this year, as these companies are key suppliers to U.S. AI firms and currently hold a large share in emerging market benchmark indices. Additionally, the MSCI South Africa Blue Chip Index (mainly composed of mining and banking stocks) has risen 15% this year, reaching an all-time high.

Edward Evans, portfolio manager for emerging market equities at Ashmore Group, added that the momentum behind the stock market rise is not solely driven by the AI boom and a weak dollar. He believes that many companies in developing markets, such as fintech and e-commerce groups in Latin America, are themselves globally competitive "market leaders."

Large-scale capital shift from U.S. stocks to emerging markets

Institutional investors' position adjustments show a clear trend of "de-Americanization" and diversification. A recent analysis by Bank of America of global "long-only" funds managing trillions of dollars found that these funds sold off $160 billion in U.S. stocks last year while buying $109 billion in Asian market stocks outside Japan and $59 billion in other emerging market stocks.

Alper Gocer, head of emerging market debt at Pictet Asset Management, stated that investors are not fleeing the dollar in a panic but are seeking new capital allocation options. He noted that investors are beginning to seek diversification, with emerging markets, especially local currency debt, becoming one of the quality alternatives.

Bonds and exchange rates perform strongly, undeterred by arbitrage trading risks

In the fixed income space, emerging market assets have also outperformed their developed market counterparts. The JPMorgan Emerging Market Local Currency Bond Index, after achieving a 19% return in 2025, has risen over 2% this year. In contrast, U.S. high-yield bonds, which compete for capital, have seen a rise of less than 1% this month.

It is noteworthy that this rebound has not been affected by warnings of yen intervention. Despite recent reports that the U.S. may coordinate with Japan to intervene in the currency market, leading to a nearly 3% rise in the yen against the dollar, this has not triggered a comprehensive unwinding of "arbitrage trades" that would impact emerging market assets as it has in the past.

Barclays analysts pointed out that there has been no damage to emerging market assets this year due to short covering in the yen. On the contrary, the "confidence shock" in the dollar is triggering strategic catch-up allocations to emerging market local currency assets that have lagged for a long time. Data from fund monitoring agency EPFR shows that investors added $1.5 billion to emerging market local currency bond funds last week, marking the largest single-week increase since 2018. Morgan Stanley's James Lord emphasized that this is not just a short-term arbitrage behavior by hedge funds in the foreign exchange market, but a genuine buying of emerging market local currency bonds reflected in official international balance of payments data.