Emerging Market Currencies Gain as U.S. Dollar Weakens Amid Policy Shifts

Emerging Market Currencies Gain as U.S. Dollar Weakens Amid Policy Shifts

As of June 27, 2025, the currency markets are witnessing significant movements, with emerging market currencies appreciating against a weakening U.S. dollar. This trend is influenced by recent policy decisions and shifting investor sentiments.

U.S. Dollar Decline and Its Implications

The U.S. dollar has experienced a notable decline, attributed to President Donald Trump’s unpredictable policy decisions. This depreciation has transformed global fund managers into de facto currency traders, as they navigate increased forex volatility. Analysts highlight that limited hedging, especially by Eurozone pension funds holding substantial unhedged dollar assets, has made portfolios vulnerable to further declines. While U.S. stocks have rebounded in dollar terms since an April tariff shock, European investors have seen declines due to currency conversion. European stocks have outperformed, particularly when calculated in dollars. With currency-specific risk rising—as much as 30% of total risk for euro-based investors—fund managers are grappling with how to safeguard portfolios amid ongoing dollar depreciation. Although a sudden dollar drop might boost U.S. exports and asset appeal, the current gradual weakness undermines confidence in a return to American exceptionalism, prompting investors to consider diversifying away from the U.S. Dollar weakness is turning all fund managers into currency traders

Emerging Market Currencies on the Rise

In response to the dollar’s decline, emerging market currencies have shown resilience and appreciation. A Reuters poll conducted between May 30 and June 4, 2025, reveals that most emerging market (EM) currencies are expected to maintain or extend their gains against a weakening U.S. dollar over the next six months. This trend follows a shift in investor sentiment away from the U.S. due to President Donald Trump’s inconsistent trade policies and concerns over the U.S. fiscal outlook, prompting capital outflows and favoring EM assets. Over 50 FX strategists surveyed indicated that while many EM currencies will remain stable or appreciate, a few may lose only a fraction of their earlier gains. High-yielding currencies such as the Brazilian real and South African rand have already surged by 10% and 6% respectively this year. However, the Turkish lira, the poorest performer among EM currencies, is forecast to decline further by 8%. In Asia, currencies like the Chinese yuan, Indian rupee, Korean won, and Thai baht are expected to experience modest appreciation. Analysts caution that sentiment towards the dollar could shift, posing a short-term risk to EM currency performance. The dollar’s status as a funding currency amid recession fears continues to support the popularity of the EM carry trade. Most emerging market currencies set to hold on to gains – Reuters poll

Impact on Global Trade and Investment

The weakening dollar has also revitalized interest in emerging market local currency debt after a prolonged 14-year period of minimal foreign investment. In recent weeks, these bond funds have experienced record inflows, driven by reduced U.S. dollar strength, lower developed market interest rates, and a global search for higher yields. Though the inflow volumes remain modest, investment is showing promising momentum across major emerging economies like Brazil, Mexico, India, and Indonesia. Returns on local currency bonds have surpassed 10% since the start of the year, significantly outpacing their hard-currency counterparts. Analysts from JPMorgan, Bank of America, and other institutions highlight this trend as a potential turning point, with undervalued emerging market bonds in countries such as South Africa, Turkey, and the Philippines becoming more attractive. This rise marks a tentative shift as international investors begin diversifying away from U.S. assets following years of dollar dominance. While current capital movement is described as a “trickle,” even small reallocations from the vast U.S. markets could have substantial impact on the smaller emerging markets due to their scale and relative valuation. Emerging market local currency debt could end decade-long drought as dollar wanes

Conclusion

The current currency market dynamics underscore the interconnectedness of global economies and the impact of policy decisions on currency valuations. As the U.S. dollar continues to weaken, emerging market currencies are poised to benefit, attracting investors seeking higher yields and diversification. However, market participants should remain vigilant, as currency markets are inherently volatile and influenced by a myriad of factors.