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(Bloomberg) — Major Wall Street banks are gearing up for another strong year in emerging markets, predicting that dollar weakness and the investment explosion in artificial intelligence will offer a further boost to the asset class.
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Those tailwinds are expected to add to this year’s gains in emerging markets, with bonds in local currencies handing investors a 7% return, the best since 2020, and a currency gauge up more than 6%. The rally should extend, underpinned by the likelihood of more Federal Reserve interest-rate cuts as the US economy slows, according to Morgan Stanley strategists.
The bank is advising clients to stick to long positions in local-currency emerging-market debt, forecasting returns of roughly 8% by mid-2026. On emerging dollar debt, it sees gains in the “high single-digits” over a 12-month period.
“Fed rate cuts will put downward pressure on the dollar. That helps Treasury yields move lower and creates a good backdrop for emerging markets,” said James Lord, head of Morgan Stanley’s emerging-market FX strategy.
The outlook hinges also on emerging-market currency appreciation against a weaker dollar. A Bloomberg index tracking carry-trade returns across eight emerging markets — funded by short positions in the dollar — has climbed more than 12% this year amid recent declines in the dollar, marking the strongest performance since the global financial crisis.
Several other banks share that optimism, with Bank of America Corp. and Goldman Sachs Group Inc. also forecasting a weaker dollar. BofA strategists expect emerging local bonds to return more than 10% next year and highlight the Turkish lira and the Brazilian real as their top carry-trade recommendations.
“The BofA baseline envisages a weaker USD; lower rates; low oil prices; and moderately higher equities,” strategists led by David Hauner wrote in a note, though they warned volatility could be higher than in the past six months.
“History shows that risk premium typically does not stay this low for an extended period,” they said.
An additonal source of support should be the huge capital spending programs that companies have announced in the artifical-intelligence space, according to JPMorgan Chase & Co. which forecasts US AI-related capex at $628 billion in 2028. The impact should be felt in emerging markets via tech exports and higher metals prices, the bank said.