Capital Is Flowing Into Emerging Markets — Here’s Why (and What To Do Next)

A weak dollar is putting pressure on the Fed but creating opportunities elsewhere

Over the last six months, a powerful but under-the-radar trend has emerged: capital is pouring into emerging markets. While the headlines still follow AI and U.S. tech stocks, global investors have been quietly rotating into funds like:

• EEM (iShares MSCI Emerging Markets) — up ~15%

• BKF (iShares MSCI BRIC) — up ~19%

• IEV (iShares MSCI Europe) — up ~21%

Compare that to the S&P 500’s ~9% gain over the same period, and a clear message is forming: the next leg of global growth may lie outside the U.S..

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The Dollar’s Decline Is Fueling the Rally

The U.S. Dollar Index (DXY) is down nearly 15% year-to-date, marking one of the steepest dollar declines since 2009. This has unleashed global capital flows in several ways:

• Emerging market equities become more attractive (both fundamentally and via FX effects).

• U.S. dollar-denominated debt becomes easier to service for EM countries.

• Foreign investors rotate into local-currency assets with stronger growth potential.

💡 Most EM ETFs are unhedged — meaning a weaker dollar directly boosts your returns.

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We Need to Talk about the Weak Dollar

At first glance, it may seem strange: the Federal Reserve hasn't cut rates, yet the U.S. dollar is falling sharply. Here's what's really going on.

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1. Markets Are Forward-Looking

• The dollar trades not just on current rates, but on expectations of future policy.

• Markets are increasingly pricing in multiple rate cuts by the Fed over the next 12 months — even if they haven’t started yet.

• In contrast, the ECB and other central banks have pushed back on easing, leading to tighter relative monetary conditions abroad.

As rate differentials narrow or flip in favor of other currencies, capital flows out of the dollar — weakening it.

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2. Financial Conditions Have Loosened Despite High Fed Rates

• The U.S. has seen rising stock prices, tighter credit spreads, and lower real yields — all of which contribute to easier financial conditions.

• This environment encourages carry trades into foreign assets with better growth or yield potential, and often results in selling dollars to buy foreign currencies.

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3. Twin Deficits and Long-Term Concerns

• The U.S. is running both a large budget deficit and a trade deficit.

• These "twin deficits" raise questions about sustainability and future dollar demand, particularly from foreign central banks.

Foreign demand for U.S. Treasuries (as seen in TIC data) has declined — weakening structural support for the dollar.

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4. Global Rotation Into Risk Assets

• As global investors turn more optimistic about growth in Europe, Asia, and emerging markets, they rotate capital into those markets.

• Since most foreign investments require converting dollars into local currencies, the dollar weakens as a result.

Key Drivers of the Trends

1. Diverging Growth Outlooks

• India is growing at 6–7%, with a booming middle class and surging digital economy.

• China is stabilizing after a tough 2023, helped by policy stimulus and AI tailwinds.

• Brazil and Mexico are riding commodity demand and a nearshoring wave.

Meanwhile, U.S. growth is slowing, and investors are looking for the next engine.

2. Commodity Supercycle

• Brazil (oil, iron ore), Chile (copper), Indonesia (nickel), and South Africa (platinum) all stand to benefit.

• Global energy transition needs are reviving demand for core EM exports.

3. Valuation Gap

EM equities are still cheap relative to U.S. stocks on P/E and price-to-book metrics. With sentiment recovering, this creates upside room.

4. Stable policy attracts capital in contrast to U.S. tariff turmoil

Relative calm and investor confidence in Europe, with €100 billion flowing into European equity funds through mid‑2025

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Top Contributors to EEM (Emerging Markets ETF)

Top Contributors to BKF (BRIC ETF)

What Should Investors Do?