Emerging market currencies have lost all their gains from 2026, with several now near or at record lows against the US dollar. This reversal comes after a period where the dollar had fallen by approximately 10% on a trade-weighted basis through early 2026, hitting a four-year low.
This shift is attributed to a reassessment of Federal Reserve policy expectations and a robust US labor market. JPMorgan, for example, upgraded its dollar outlook in mid-May 2026. Prior to this, the consensus had been that the Fed would continue easing, narrowing interest rate differentials with emerging markets and weakening the dollar, which led to significant inflows into higher-yielding EM assets. The Colombian peso had surged nearly 20%, and the South African rand and Israeli shekel also posted double-digit gains.
The strengthening dollar has created a challenging situation for emerging market economies, particularly those with dollar-denominated debt. As the dollar rises, the cost of servicing these debts in local currency terms increases, even if underlying financial conditions haven't changed. This can lead to capital outflows, further weakening local currencies and making dollar debt even more expensive in a phenomenon described as a "dollar-debt doom loop." Central banks in these regions are now contemplating strategies like holding interest rates higher for longer or intervening in currency markets.
Examples of currencies under pressure include the South Korean won, which has fallen to record lows, and the Indian rupee, which has seen increased scrutiny over the Reserve Bank of India's intervention strategies. The rupee recently hit a near three-week low at 95.2475 per dollar, its worst one-day fall since June 8. This rapid reversal highlights that emerging market currency trades are closely linked to US monetary policy, and assumptions of a weak or neutral dollar are crucial for the profitability of carry trades.
