Would a Weaker US Dollar Support Emerging Market Assets?

Emerging market equities and bonds could benefit if the US dollar weakens—a possible scenario amid tariff turmoil.

The US dollar (USD) has weakened recently but remains historically expensive compared with most currencies. If the slide in the world’s go-to currency persists, however, we believe it could support a recovery for emerging-market (EM) stocks and bonds.

How Does a Weaker Dollar Help EM Assets?

A falling dollar supports EM assets mainly through three mechanisms. First, a weaker dollar can attract more inflows as investors seek higher returns in a depreciating-dollar environment, potentially stimulating corporate and economic growth as well. Moreover, bond issuers benefit when the cost to service their debt drops, since many EM sovereigns and corporate bonds are denominated in US dollars. Commodities prices, a key driver across many EM economies, also tend to rise when the dollar weakens—another potential tailwind. Of course, President Trump’s rapidly shifting tariff agenda continues to add layers of unpredictability and risk to the equation, which could change the dynamics of these mechanisms.

It’s uncertain if the USD will fall from here, particularly since US policy direction remains in flux. But we see ample room for more weakening. In fact, the dollar’s strength is near long-term peaks based on the real effective exchange rate, a measure of a broad basket of country currencies adjusted for inflation. The greenback hasn’t been this strong since 1985, when it forced the then G5 to reach the Plaza Accord, a devaluation agreement in the interest of healthy global trade and economic balance.

Revisiting the Dollar’s Journey

The USD’s valuation path in the last two decades especially supports our case for EM assets (Display). EM stocks, for instance, outperformed developed market equities as the dollar weakened or stabilized, which occurred from 2004 to 2011.

Further, a weakening USD would likely compress bond spreads, as default risk tends to ease when debt servicing cheapens. We saw this among EM sovereign spreads for most of the 2000s—and saw the opposite, with spreads widening, when the USD strengthened from 2014 to 2016 and again in 2022 (Display). Today, spreads remain relatively tight but not compared to history. Should they compress further, EM bond prices would rise relative to US Treasuries.

With US exceptionalism now under more scrutiny, we think investors should reevaluate their overweight to US-dollar-based assets. Favorable currency dynamics could be a catalyst that augments the broad opportunity set across equities, sovereigns and corporate bonds.

The authors would like to thank Adriaan Du Toit, Director—EM Economic Research, and Richard Cao—Portfolio Manager, Multi-Asset Solutions at AB for their contributions to this blog.