The retreat of the US dollar and expectations of interest rate cuts by the Federal Reserve ignite risk appetite! Emerging market assets sound the horn for a counterattack

According to Zhitong Finance APP, the benchmark index measuring sovereign currencies and stocks of developing economies globally rose on Monday, achieving its best performance in recent months, primarily due to a rebound in risk asset sentiment amid market speculation that the Federal Reserve is about to resume its rate-cutting cycle and the continued weakness of the US dollar, which has recently driven a broad resurgence in emerging market assets.

The camp of investment institutions optimistic about emerging market assets continues to expand, including favorable macro tailwinds such as the Federal Reserve possibly cutting rates soon and the gradual collapse of the "American exceptionalism" narrative due to Trump’s tariff policies and immigration restrictions. Institutions that have long focused on developed markets like the US, including JP Morgan and Amundi SA, are beginning to shift their asset allocation focus towards emerging markets like China.

The MSCI Emerging Market Currency Index, which has performed weakly for most of this year, has risen nearly 0.5%, marking the largest single-day gain in over a month, while the similar MSCI Emerging Market Stock Index rose 0.9%, outperforming developed market indices.

Investors are generally betting that the Federal Reserve will cut the benchmark interest rate as early as next month, with a change in the Federal Reserve Board imminent—likely the first step by Trump to install rate-cutters among the FOMC voting members—and the dismissal of the chief labor statistician by the Trump administration. Both events have led to increasing market concerns about the independence of the Federal Reserve and statistical agencies. These factors, combined with Trump’s tariffs and immigration restrictions, and a significant expansion of the fiscal deficit, have further deteriorated the outlook for US economic growth, increasing the risk of a weaker dollar. A continued weakening of the dollar often means that emerging market assets are likely to maintain a strong upward trend.

"The bearish argument for the dollar index remains valid. Although there are reasons to believe that the backdrop for risk assets may become more turbulent than ever, the continued weakening of the dollar index driven by expectations of Fed rate cuts will naturally support emerging markets," wrote James Lord and Simon Weaver, emerging market strategists at Morgan Stanley, adding that they are gradually increasing their exposure to emerging market currencies.

Following the significantly weaker-than-expected July non-farm payroll data, which faced a downward revision of up to 90% for the previous two months, Wall Street's outlook on the momentum of US economic growth has turned pessimistic, and expectations for Fed rate cuts have surged. This non-farm employment report not only revealed a surprising employment figure of just 73,000 for July but also unexpectedly revised down the employment data for May and June, cutting a total of up to 258,000 jobs, with a downward revision of an unprecedented 90%.

As a result, this non-farm data has largely driven traders to bet heavily on Fed rate cuts: the interest rate futures market pricing shows that traders are betting heavily on the resumption of the Fed's rate-cutting cycle, with the probability of a rate cut next month approaching 90%—up from less than 40% before the non-farm report—and betting on at least two rate cuts by the end of the year, even wagering on consecutive cuts of 25 basis points in September and October, plus a 25 basis point cut in December, cumulatively betting on three cuts totaling 75 basis points by year-end Emerging market currencies retreated from their intraday highs on Monday after U.S. President Donald Trump threatened to raise tariffs on the Indian government above the 25% punitive tariff rate announced last week—due to New Delhi's continued purchase of Russian oil. On August 4th, local time, President Trump posted on his social media platform "Truth Social" that India not only purchases a large amount of Russian oil but also sells most of it on the open market for profit. Therefore, he announced a significant increase in tariffs that India would pay to the U.S., although the specific figures were not disclosed in the tweet.

The iShares MSCI India ETF, with a scale of up to $10 billion, fell by 0.6% at one point. Trump's latest post regarding Indian tariffs did not specify how much the tax rate would be increased, which somewhat suppressed market sell-off sentiment.

"Those who believed that once the negative impact of tariffs on the U.S. economy became apparent, Trump might reconsider his tariff strategy have now been proven wrong," wrote Thu Lan Nguyen, head of foreign exchange and commodity research at Commerzbank, in a report. "This U.S. president clearly prefers to cover up issues rather than face reality."

Key to Emerging Market Assets: Dollar and Federal Reserve Trends

Jeffrey Gundlach, CEO of global asset management giant DoubleLine Capital, known as the "new bond king," recently stated that as Trump's series of radical policies lead to the gradual collapse of "American exceptionalism" and the Trump administration begins to erode the independence of Federal Reserve monetary policy, the dollar is almost certain to enter a long-term depreciation curve, and international stocks represented by emerging markets are expected to continue outperforming the U.S. stock market.

Trump stated that he would announce the nomination of a new Federal Reserve governor in the coming days, which could bring a policymaker more aligned with Trump's preference for low interest rates. This vacancy arose because Adriana Kugler announced on Friday that she would resign early for personal reasons—her term was originally set to end in January next year.

Trump will also announce a replacement for the head of the U.S. Labor Department's Bureau of Labor Statistics, a move that market investors generally view as potentially undermining the long-standing "data credibility" of this statistical agency.

The Philippine peso performed the best among emerging market sovereign currencies, rising about 1% against the dollar. Most Asian currencies also strengthened significantly against the dollar, with Goldman Sachs' foreign exchange strategist team expecting the Korean won and New Taiwan dollar to outperform other emerging market currencies in the region.

"If the Federal Reserve resumes its rate-cutting cycle in September and releases more dovish policy signals, it could provide significant support for Asian currencies," wrote Lloyd Chan, a foreign exchange strategist at MUFG Bank, in a report. He added that the risks facing the region's currencies come from the implementation of higher tariffs by the U.S., which could weigh on emerging market exports.

Colombian dollar-denominated bonds were among the best performers in emerging market assets on Monday, after the Colombian government announced it would repurchase some of the globally circulating bonds in cash to reshape its government financing strategy amid concerns over an expanding deficit Is the Road to a Comeback for Emerging Markets Opening?

More and more Wall Street investment institutions are optimistic about the future trends of emerging markets, including Morgan Stanley, JPMorgan Chase, and Goldman Sachs, all of which are bullish on the upward momentum of emerging markets amid a weakening dollar and a Federal Reserve rate-cutting cycle.

Since the beginning of this year, with Trump's global tariff policies and immigration restrictions, along with the introduction of the "Big and Beautiful" bill that significantly boosts the budget deficit, the notion of "American exceptionalism" has gradually collapsed. This has led some international investors and even certain asset management institutions on Wall Street to continuously sell off U.S. assets since the beginning of this year, turning instead to Europe and emerging markets.

Wall Street financial giant JPMorgan Chase has reaffirmed its strong bullish stance on emerging market (EM) stocks against the backdrop of the robust performance of emerging markets this year, favorable macro tailwinds, and the soaring Chinese stock market.

Before JPMorgan Chase turned bullish on emerging market stocks, European asset management giant Amundi SA shifted from a long-standing focus on U.S. asset allocation to betting on the appreciation trends in Europe and emerging markets, preparing to cope with potential new rounds of severe volatility in the U.S. stock, bond, and currency markets triggered by U.S. White House tax policies and global trade policies.

"As of last year, investors still held very light positions in emerging markets, and most had viewed the Chinese stock market, which has the largest weight in emerging markets, as a clear structural underweight. Although this situation has not changed significantly, the stance of most investors towards the Chinese stock market has shifted, especially as passive ETFs focusing on A-shares and Hong Kong stocks have resumed their growth path. Notably, the U.S. has retreated from the brink of confrontation in trade negotiations with China, which is a significant positive," said Mislav Matejka, a stock market strategist from JPMorgan Chase.

Matejka from JPMorgan Chase believes that expectations of a long-term weak dollar and the possibility of the Federal Reserve cutting rates two times or more this year will help enhance the growth performance of emerging market currencies and stock prices. Specifically regarding emerging markets, the Chinese stock market will remain the focus of allocation, while JPMorgan Chase is optimistic about India, South Korea, and Brazil among other emerging markets