A structural reversal in global capital allocation away from US assets now appears to be underway. We expect this to weaken the US dollar and provide significant support to emerging markets, which are increasingly well-positioned to benefit from this rebalancing in global portfolio flows.
The world is overexposed to US assets. Since the global financial crisis in 2008, the allocation of US assets in global investment portfolios has increased rapidly, reaching extreme levels. Although this trend has been recognised as unsustainable for some time, a combination of key factors has continued to reinforce it. These include large fiscal deficits in the post-Covid period, persistent weakness in eurozone growth, the dominance of the US technology sector, and a prolonged period of elevated interest rates in the US. These dynamics pushed US equities higher and strengthened the dollar, despite the widening US twin deficits, leading to a deeply negative and expanding net international investment position.
Until now, no clear catalyst has emerged to reverse the trend of US dominance. The Trump administration has taken bold steps to recalibrate US trade and foreign policy, marking a potential turning point. Officials argue that a strong dollar and excessive trade openness have eroded US manufacturing and undermined the economic prospects of the country. This policy shift could catch global investors off guard, given the world’s heavy exposure to US assets.
It is, however, worth noting that significant shifts in asset allocation away from the dollar can occur without it losing its reserve currency status. We believe the dollar will remain the dominant global reserve currency for years to come, primarily because no legitimate contender currently exists. The convenience of dollar-based trade invoicing, the depth and liquidity of US capital markets, and the scale of the US economy all contribute to strong institutional inertia. In any case, transitions away from established reserve currencies typically unfold over periods well beyond the timeframe considered here.
Emerging markets are well-positioned to benefit from a rotation out of US assets given their strong fundamentals and attractive valuations. Unlike the vulnerabilities plaguing the US, many emerging economies are robust. They feature healthy external balances, manageable debt levels, high real interest rates, and undervalued currencies. As global capital flows adjust to shifting fundamentals and policy priorities, investors seeking both growth and policy orthodoxy are likely to view emerging markets as a less hostile investment destination. This rebalancing of portfolios in favour of EM is likely to be driven by both local repatriations and foreign investors’ reallocations after several years of being severely underinvested.
With the era of US dominance in global portfolios potentially having reached its peak, and policy dynamics shifting both within the US and abroad, we expect a meaningful rotation of global asset allocation to commence. Emerging markets are poised to benefit significantly from this transition, and investors may need to reassess their portfolio strategies to align with the evolving global investment landscape.
Nathan Chandler, Assistant Portfolio Manager, Emerging Markets Debt, Schroders
*** The views expressed here do not necessarily represent those of Independent Media or .
BUSINESS REPORT
