The Dollar Falters, Emerging Markets Rise: What Investors Should Know

Global currency markets have experienced sharp fluctuations in recent years, and in 2025, these movements have increasingly drawn attention to emerging market (EM) currencies.

 Once considered niche or high-risk, these currencies are now playing a more prominent role in global finance as investors search for returns amid shifting economic conditions.

Emerging Market Currencies Gaining Attention

Emerging market currencies are the national currencies of countries whose economies are still developing or transitioning toward greater industrialisation and income levels. Examples include the Hungarian forint, Brazilian real, Mexican peso, and South African rand.

In 2025, several of these currencies have experienced unusually large price movements — known as currency swings — both upward and downward. Currency swings refer to rapid changes in the exchange rate between two currencies, such as the number of U.S. dollars one unit of a foreign currency can buy.

For example, the Brazilian real strengthened noticeably against the U.S. dollar in the first half of 2025, following investor optimism about economic reforms. Meanwhile, the Indian rupee experienced sharp swings in response to changes in domestic interest rates and foreign capital flows.

Some EM currencies have strengthened significantly against the U.S. dollar, attracting investors who previously focused on more established markets like the euro or Japanese yen. This surge in interest has pushed indices such as the MSCI Emerging Market Currency Index — a benchmark that tracks the performance of multiple EM currencies — to near-record levels.

Why a Weaker Dollar Matters for Emerging Markets

Movements in the U.S. dollar have far-reaching consequences for the global economy, particularly for emerging markets. When the dollar weakens, it often reflects changes in U.S. monetary policy, economic conditions, or investor sentiment — each of which can significantly affect capital flows, exchange rates, and financial stability in developing economies.

According to financial content, "a weaker dollar typically benefits Emerging Market (EM) economies, making their dollar‑denominated debt cheaper to service and often triggering capital inflows towards their higher‑yielding assets.”

Several key factors can drive a weaker dollar, and understanding them helps explain why emerging markets often move into the spotlight during these periods.

Expectations of Lower U.S. Interest Rates

One of the most common drivers of dollar weakness is the expectation that the U.S. Federal Reserve will lower interest rates. Interest rates determine the returns that investors earn on assets, such as government bonds. Higher rates tend to attract foreign capital, increasing demand for the dollar, while lower rates reduce its appeal.

Even the anticipation of future rate cuts can weaken the dollar, leading investors to adjust their portfolios and assets in advance. When U.S. assets offer lower returns, global capital begins to seek better yields elsewhere.

For emerging markets, this shift can be beneficial. Many EM countries offer higher interest rates to compensate investors for greater economic and political risks. 

As money flows into these markets, their currencies often strengthen and borrowing costs fall.

Rising Government Debt and Fiscal Concerns

Concerns about rising U.S. government debt can also pressure the dollar. Government debt refers to the total amount a country owes due to borrowing to fund public spending. When debt levels rise rapidly, investors may worry about long-term fiscal sustainability, inflation risks, or the potential erosion of real returns.

Such concerns can erode confidence in U.S. assets, including Treasury bonds, which are traditionally regarded as among the safest investments globally. If demand for these assets falls, so does demand for the dollar.

For emerging markets, this environment can attract capital as investors seek diversification away from heavily indebted developed economies. However, fiscal concerns can also increase global market volatility. If investor confidence deteriorates sharply, capital may retreat from riskier assets, including those in emerging markets, leading to sudden declines in currency and asset prices.

These currency movements not only affect countries and investors, but also shape the behaviour of major financial institutions.

Benefits for Banks and Hedge Funds

Rising volatility in currency markets has created significant opportunities for banks and hedge funds, with EM currencies at the centre of this trend. Compared with developed-market currencies, EM currencies tend to experience larger and more frequent price swings, making them especially attractive to professional traders.

Currency volatility measures the extent and speed of exchange rate fluctuations. EM currencies are typically more volatile because they are influenced by a broader range of economic and political factors, including inflation shocks, changes in monetary policy, elections, capital flows, and fluctuations in commodity prices.

Unlike developed economies, many EMs rely more heavily on foreign investment to finance growth. This makes their currencies highly sensitive to shifts in global investor sentiment. Nevertheless, when money flows in, currencies can strengthen rapidly; when sentiment turns, they can weaken just as quickly.

The rise in currency volatility has been particularly profitable for banks and hedge funds.

Banks

Banks earn revenue from facilitating foreign exchange trades for clients and from trading currencies themselves.

Banks, particularly large international institutions, benefit from emerging markets by earning revenues through currency trading, hedging services, and market-making activities. 

The greater volatility of EM currencies leads to higher trading volumes and wider bid-ask spreads, making these markets more profitable than traditional developed-market currencies in certain periods. 

Banks also play a crucial role in facilitating cross-border trade and investment, helping emerging economies access global capital.

Yet this exposure comes with risks. During times of market turmoil, banks may scale back their activities to protect their balance sheets, reducing liquidity when it is most needed. This can exacerbate currency fluctuations and increase borrowing costs for emerging market governments and businesses, underscoring the deep interconnection between these economies and global financial institutions.

Hedge Funds

Hedge funds are investment funds that use advanced strategies — including leverage and derivatives — to profit from price movements across markets. Hedge funds have found emerging market currencies particularly attractive because their higher volatility and sensitivity to economic and political developments create opportunities for outsized returns. 

Hedge funds often operate on large scales, deploying significant amounts of capital, and on short time horizons, meaning they can enter and exit positions rapidly. This combination enables them to generate outsized returns during periods of steep currency movements, but it also means their trading can amplify volatility in emerging markets.

This activity can bring benefits to emerging markets by increasing liquidity and improving price discovery, making it easier for governments and companies to hedge currency risk. 

However, hedge fund participation also carries drawbacks. Investors can move capital quickly, but they may exacerbate market swings during periods of stress, contributing to sudden currency depreciations and financial instability.

The speed and size of hedge fund capital flows can have direct consequences for emerging economies. Large, rapid inflows can strengthen EM currencies and boost liquidity, while sudden withdrawals can trigger sharp depreciations, stress local financial systems, and increase borrowing costs. 

Although hedge fund activity can enhance price discovery and market efficiency, it also underscores the vulnerability of emerging markets to fluctuations in global investor sentiment, particularly during periods of economic or political stress.

Conclusion

Wild currency swings have placed emerging markets firmly in the global spotlight. A combination of a softer U.S. dollar, shifting investor behaviour, and improved fundamentals in some countries has created renewed interest in EM currencies.

According to Reuters, "trading in some emerging market currencies has more than doubled as a weaker U.S. dollar and shifting investor sentiment prompt traders and fund managers to rethink traditional currency allocations".

While opportunities for returns have increased, so have the risks. For investors, policymakers, and financial institutions alike, understanding the dynamics behind emerging market currencies is now more important than ever in navigating an increasingly volatile global financial system.