Despite a major geopolitical shock, Emerging Market currencies have held up remarkably well. In contrast, EM rates markets have shown significant stress, indicating painful positioning squeezes and a reassessment of inflation risks by investors. This divergence signals underlying strength in some areas but reveals hidden fragilities in others.

While a stronger growth environment supports EM currencies, it is problematic for low-yielding EM government bonds. Their valuations were based on aggressive local central bank easing cycles which now have less scope to continue, especially with a potentially shallower Fed cutting cycle, making them vulnerable to a correction.

Despite investor nervousness after a strong 2025, EM currencies could appreciate against the dollar again in 2026. Analysts argue that the 14-year bear market has turned, citing historical precedent from the 2002-2010 bull market where consecutive positive years were common. This challenges the prevailing investor caution.

Contrary to common heuristics, recent market action shows the US 10-year real yield has a more significant and consistent impact on EMFX than oil prices. Even as oil rose, the easing in US real yields provided a stronger positive influence on EM currencies, demonstrating its relative importance.

Despite record-high economic activity surprises, emerging market currencies (EMFX) are fairly valued, not overextended. This suggests near-term upside for spot prices is limited, making carry returns the more likely driver of performance in this bullish cyclical environment.

While broad emerging market currency indices appear to have stalled, this view is misleading. A deeper look reveals that the "carry theme"—investing in high-yielding currencies funded by low-yielding ones—has fully recovered and continues to perform very strongly, highlighting significant underlying dispersion and opportunity.

Stronger US growth isn't hurting EM currencies because growth is also being revised up globally in places like China and Europe. This prevents a repeat of the 'US exceptionalism' theme that typically strengthens the dollar and pressures EM assets, making the current environment less problematic for EMFX.

The traditional correlation where rising rates hurt Emerging Market currencies is breaking down. Strong, synchronized global growth and a multi-year trend of EM growth upgrades are supporting EMFX. This dynamic allows currency carry trades to perform well even as local bond markets sell off due to higher rates.

Unlike local rates, the EM FX market has been less volatile amid recent geopolitical escalations. A key technical reason is that very little capital was positioned in the asset class to begin with, meaning there were fewer positions to be squeezed out, thus dampening the market's reaction.