Sahil Mahtani, Director, Investment Institute at Ninety One
The dollar’s structural downcycle is far from over, but investors expecting another sustained leg lower may be disappointed. Two of the biggest obstacles to dollar weakness sit not in Washington, but in Paris and Beijing. Political instability in France threatens to constrain the euro, while China’s reluctance to allow significant renminbi appreciation could hold back Asian currencies. Together, these forces could keep the dollar trading sideways over the next 12 months.
For emerging markets, the distinction matters. A weaker dollar has historically been a powerful driver of returns. Capital flows into non-US assets can reinforce this dynamic, which is why emerging market bull markets have often coincided with dollar downcycles.
Last year we argued that the dollar’s 14-year upcycle was ending. The dollar is down 6.8% from its peak in 2025 in real trade weighted terms. Tariffs and inconsistent US policy on Ukraine lifted European and Japanese defence spending, narrowing interest rate differentials. Wider US fiscal deficits, pressure on the Federal Reserve and increased currency hedging have also contributed.
Sahil Mahtani, Director, Investment Institute: ” The dollar’s decline was never going to be a straight line. The structural forces that brought its 14-year upcycle to an end remain in place, but political uncertainty in France and China’s currency policy could delay the next leg lower.”
France: political instability caps the euro
The euro is more than half of the DXY index and the largest weight in the Fed’s broad trade-weighted measure. The dollar struggles to fall far without the euro rising, and it is hard to see investors buying the euro with conviction while France’s public finances are in play.
Prime Minister Sébastien Lecornu’s minority government presented its 2027 budget in early October with 10-year OAT yields near 5%, the highest since 2002. The spread over Bunds, which sat between 30 and 45bp from 2014 to 2022, recently touched 160bp before settling around 135-140bp.
Parliament votes in mid-November. If the budget fails, the most likely outcome is a special law rolling over this year’s budget, as when Michel Barnier’s government fell in December 2024. That implies a 2027 deficit above 6%, for a country where nominal GDP is growing under 3% a year. If it passes, it is only a holding operation, with no guarantee that the next budget passes.
The bigger risk comes after the budget. Presidential elections in April and May 2027, followed by legislative elections in June, could produce another hung assembly, leaving France with a new president, but no parliamentary majority or durable budget, extending uncertainty into 2028.
Would the ECB step in? Ultimately, yes. France is too big to fail, and the ECB has stronger tools than during the euro crisis. However, the ECB is unlikely to act until the OAT–Bund spread gets well above 200bp and likely 250bp, and stress has spread to Italy and Belgium. Until then, French risk will weigh on the euro.
Mahtani: “France’s fiscal problems are not simply a domestic political issue. With the euro accounting for more than half of the dollar index, prolonged uncertainty in France could constrain euro appreciation and, in turn, limit the scope for further dollar weakness.”
China: the missing catalyst for Asian FX
The other route to a weaker dollar runs through East Asia. Past dollar downcycles have been helped by a large surplus currency appreciating: the yen after the 1985 Plaza Accord, the renminbi after China loosened its strict dollar peg in 2005. The renminbi is the obvious candidate again. The IMF puts its undervaluation at about 20%, and some estimates suggest 30%. It has gained about 4% against the dollar this year, but the People’s Bank of China has leaned against faster gains, most recently on 8 October. Because much of Asian FX is correlated with the renminbi, a managed yuan caps a large part of the EM currency universe too.
Beijing has little reason to hurry. Gross debt stands at around 300% of GDP, while interest payments are rising relative to output. Unlike 1980’s Japan, China does not depend on a foreign security guarantee and it controls its own supply chains. It may let the renminbi rise gradually, on its own terms and in the service of internationalising the currency. A rapid move towards fair value looks unlikely. Europe’s tougher trade stance, including the 5 October Macron–Merz “non-paper” on a rapid-response trade instrument, adds pressure, but Beijing has promised a “resolute response”.
Mahtani: “China has little incentive to allow a rapid appreciation of the renminbi. That matters beyond China itself: with Asian currencies closely linked to the yuan, Beijing’s policy choices could constrain a broader emerging-market currency rally.”
Why the downcycle remains intact
Dollar downcycles take time. The last three (the 1970s, 1985–1995 and 2002–2011) each ran for roughly eight to twelve years, with consolidations and sharp counter rallies. Three structural pressure points exist.
Concentration. US companies account for around 65% of the MSCI ACWI index, up from about half a decade ago. This leaves global portfolios heavily exposed to the dollar, creating incentives to diversify. Even a modest shift at the margin moves the currency.
Hedging. After the April 2025 tariff shock, when the dollar fell alongside US equities, foreign investors raised hedge ratios. This year, AI flows, and a hawkish Fed let them drift lower again. Bloomberg estimates that a five-point rise in hedge ratios across six major investor markets would mean over $200bn of dollar selling. The next US-specific shock, whether political, monetary or AI-related, could remind investors that the dollar carries two-way risk. The Korean won and the Taiwanese dollar remain cheap and could strengthen reflexively with repatriation.
An AI spending slowdown could be a particularly powerful catalyst. Given the concentration of global portfolios in US technology companies, disappointing returns on AI investment could trigger capital outflows and renewed currency hedging, accelerating dollar weakness. A broader global risk-off shock, however, could still support the dollar through safe-haven demand.
Diversification. Central banks have bought gold since Russia’s reserves were frozen in 2022, more trade is settled in local currencies, and Beijing keeps pushing renminbi internationalisation. None of this dethrones the dollar, but it erodes marginal demand year after year.
What this means for emerging market investors
A sideways dollar raises the importance of selectivity but does not diminish the opportunity. Improving domestic fundamentals, attractive valuations and opportunities across equities and fixed income offer sources of return beyond currency appreciation. The MSCI Emerging Markets Index trades at about 9.9x forward earnings, less than half the S&P 500’s 20x-plus multiple, the widest gap in at least two decades.
Mahtani: ” The opportunity in emerging markets extends well beyond a weaker dollar. Improving fundamentals, attractive valuations and domestic growth drivers provide a compelling foundation for returns. Investors should focus on these underlying strengths rather than relying on currency movements alone.”
The dollar’s structural downcycle remains intact, even if the next 12 months bring a pause. For emerging markets, the opportunity is broader than the direction of the dollar.
ENDS
