Emerging markets and China’s resilience amid market fragmentation and U.S. uncertainty

Global markets are shifting as U.S. uncertainty and financial fragmentation reshape investment strategies. Emerging markets and China are proving resilient, offering compelling opportunities for investors seeking growth and diversification. Read the insight to find out more about:

• Emerging market strength: Sovereign debt and local currency bonds are outperforming, supported by attractive valuations and a softer dollar.
• China’s trade resilience: Despite reduced U.S. exposure, exports to ASEAN, Africa, and Latin America are surging, driven by heavy industries and strategic diversification.
• Investor trends: Fed rate cuts and dollar weakness are fueling inflows into emerging market assets, while China maintains accommodative policies amid deflationary pressures.

Over the past decade, despite interest rates generally being higher than in the U.S., the BRICS currencies have depreciated against the U.S. dollar. The technology boom created strong demand for U.S. equities, while U.S. Treasuries remain among the most liquid asset globally. In theory, a weaker dollar should support exports; however, export levels have shown little change recently, with the most notable shift occurring in imports. Gold imports rose significantly over the summer. This may suggest that volatility and inflation could persist in the U.S. economy in the coming months, prompting American consumers to seek hedges against these risks. 

Indices tracking emerging market performance are on course for their strongest year since 2017. Sovereign debt from emerging markets has outperformed nearly all other fixed income categories, with local currency government bonds delivering returns of around 15% year-to-date. This is more than double the return of U.S. high-yield corporate bonds and well above the 5.4% gain in the Bloomberg U.S. Treasury Index. Brazil, Mexico, Colombia, Hungary, and South Africa have led the charge, each posting gains of at least 23% this year.

Emerging markets represent a substantial share of the global economy: approximately 86% of the world’s population and labour force, 77% of land, 59% of global GDP and 44% of exports – as well as most key resources (around 87% of proven oil, 83% of copper, 77% of nickel and 69% of lithium). These markets appear attractive compared with the U.S. and Europe, supported by valuation gaps, a softer dollar, and long-term growth prospects.

Despite the relatively higher risk profile of U.S. equities, investor interest remains strong, driven by optimism around artificial intelligence and productivity gains. The S&P 500 currently trades at about 22.5 times next-12-months (NTM) earnings, levels last seen in the late 1990s and early 2000. By comparison, Europe and emerging markets trade at roughly 15 times NTM earnings – a discount of around 40%.

With the Fed resuming rate cuts after a nine-month pause, investors are increasingly seeking yields outside the U.S., particularly in local currency bonds, which could benefit further if the dollar continues to weaken. These shifts reflect expectations that monetary easing will maintain downward pressure on the dollar, enhancing returns from bonds linked to appreciating currencies. If the U.S. dollar continues to weaken, returns on bonds denominated in local currencies will be further amplified.

Emerging market investments remain volatile and are generally suited to investors with a higher tolerance for fluctuations. Recent sell-offs in Turkey and Argentina highlight the unpredictability of these markets. Nevertheless, historical trends show that emerging market debt has typically returned between 6% and 8% following Fed rate cuts. This momentum has continued, with EM debt funds attracting approximately $300 million in the week ending 17 September – the 22nd consecutive week of inflows, according to EPFR data compiled by Bank of America. Year-to-date, net inflows have reached $45 billion. Interest rates in developing countries remain significantly higher than in the United States, and many emerging market central banks, mindful of inflation, have adopted a cautious approach to easing, making their asset yields comparatively attractive.

China stands apart from other emerging markets, maintaining an accommodating monetary policy in response to deflationary pressures Despite these risks, Chinese trade performance remains resilient. Exports rose by 8.3% year-on-year in September, exceeding expectations of 6% increase from Reuters Polls and marking the fastest growth since March, compared with a 4.4% increase in August. Beijing’s imports also surged by 7.4% last month, well above the 1.5% growth forecast, representing a 17-month high and surprising markets given recent signs of weaker domestic demand. 

Chinese exports to India have continued to grow, pushing New Delhi’s trade deficit with Beijing to a record $99.21 billion in the fiscal year ending March 2025. China recorded a $77.7 billion trade surplus with India as of August, up 16% from a year earlier. Bilateral trade between India and Russia also reached a record $68.7 billion in fiscal 2025, driven largely by increased oil imports, contributing to a $59 billion deficit.

The U.S. now accounts for only about 10% of China's direct exports, by destination. Exports to the U.S.  fell by 27%, offset by strong growth to other regions: the EU (14.2%), ASEAN (15.6%), Africa (56.6%) and Latin America (15.2%), all posted robust gains in September. Trade volumes have generally outpaced trade value growth, indicating that export prices have generally declined amid intense competition. 

In summary, the fragmentation of financial markets affects not only developed nations, but also emerging markets. As economic dynamics between China and the U.S. evolve, opportunities in emerging markets continue to develop, particularly in regions that are less mature than China. Moreover, the anticipated easing of the Federal Reserve’s policy rate is likely to strengthen the incentives for investors seeking higher yields. China’s diversification strategy also appears to be effective, as reflected in its growing trade surplus.