Emerging markets draw ‘wall of money’ as dollar weakens

The MSCI Emerging Markets Index closed out August with its strongest monthly performance in years, propelled by a weakening U.S. dollar after the Treasury Department doubled its planned buybacks of longer-dated government bonds. Analysts now expect a flood of capital into high-yielding developing economies through carry trades, with Brazil, Turkey, and Colombia named as the top destinations.

Treasury Buybacks Reshape the Landscape

The rally traces back to a decision by Treasury Secretary Scott Bessent in mid-August to double the size of buyback operations on longer-dated securities to at least $4 billion per operation, a move aimed at easing pressure on long-term yields that had surged amid concerns over inflation and mounting government debt. Bessent signaled the buybacks could increase further, telling reporters the program had not yet begun but hinting at additional measures ahead.reuters+2

The announcement sent the dollar lower and drew immediate attention from emerging market investors. Robin Brooks, a senior fellow at the Brookings Institution, said emerging markets are set to receive "a wall of money" as developed economies work to suppress long-term bond yields, creating favorable conditions for the carry trade — borrowing in a cheap currency to invest in higher-yielding assets. Peter Kinsella, global head of FX strategy at Union Bancaire Privée, said the Treasury's move signaled "the U.S. could potentially engage in policies which are akin to financial repression," resulting in a weaker dollar that benefited high-yielding currencies across both developed and emerging markets.cnbc

Winners in the Carry Trade

Global emerging market bond funds recorded inflows of $967 million in the week through late August, up roughly 15% from the prior week, according to TD Securities data. The South Korean won strengthened 2.83% against the dollar following the buyback announcement, while the Brazilian real gained 0.64% and the South African rand 0.59%, according to LSEG data.cnbc

Brazil and Turkey remain the most favored carry trade destinations due to their elevated nominal and inflation-adjusted yields, Kinsella said. Brazil's benchmark interest rate stands at 14%, with 12-month inflation at 4.2% as of mid-August, while Turkey's central bank held its one-week repo rate at 37% in July against annual inflation of 31.75%. Colombia has also emerged as a popular target: its currency has gained roughly 20% year-to-date, and the COLCAP stock index has risen by a similar margin, according to Wee Khoon Chong, macro strategist at BNY The Bank of New York Mellon Corporation ↗ 0.31%.riotimesonline+1

Outlook and Risks

Morgan Stanley ↗ 0.26% Investment Management noted in a late-August report that the U.S. "strong dollar" policy is waning, compressing the premium U.S. assets have commanded relative to the rest of the world and improving the outlook for emerging market returns. Brooks argued that dollar-funded carry trades are only getting underway, given that emerging markets experienced "massive outflows" during the Iran war, and that the Treasury's actions suggest "over time there could be more measures in more places with ever greater intensity".morganstanley+1

Asian currencies, however, are expected to continue underperforming their emerging market peers due to lower implied yields, according to Eric Robertson, chief strategist at Standard Chartered.cnbc