How Long Can Emerging Markets Continue To Rally? For Morgan Stanley, This Is The Key Factor

By Seth Carpenter, Morgan Stanley chief economist

Emerging market assets are having quite a year thus far – so much so that clients are asking whether it is sustainable. For markets and asset prices, the dollar’s trajectory will be a key factor determining the length of the rally. From solely an economics perspective, we think that EM economies are in a fundamentally strong position, which provides a solid basis for the performance to continue. Last year we often wrote about the stabilizing force of central bank orthodoxy and historically high real rates. In that context, growth and inflation have generally done quite well across EM. The Fed’s rate cuts to date have eased pressures on EM central banks, opening the door a bit wider for the virtuous cycle to last. But EM economies are naturally heterogeneous, and it’s worth taking a look across regions.

Politically, Latin America has a lot at stake in 2026, with elections looming in Brazil as well as Colombia and Peru, following the voting in Chile late last year. Most client conversations start with a binary focus: Will the leftward shift from the previous election cycle reverse in the new elections, as we saw in Chile? But taking a step back, the fundamentals of resilient economic growth and contained inflation suggest that whoever wins will have little incentive to make dramatic changes. Years of orthodox central banking and cautious fiscal policy have laid a foundation for LatAm economies to continue to perform, and we suspect that the trend will continue. Questions thus are likely to shift to what types of fiscal reforms are possible and whether additional interest rate cuts from the central banks can trigger a deeper virtuous cycle.

In Asia, a more complicated external story is manifest, with export-driven economies facing US tariffs on the one hand but a huge tailwind from the AI capex boom on the other. Korea and Taiwan have accelerated to above-trend growth on the back of strong exports, and that outcome is extending as we pass the peak in US tariffs. Moving past peak tariffs is also supporting an acceleration in non-tech exports that should support the region more broadly. However, Chinese growth remains subdued, albeit stable, though deflationary pressures persist. Chinese exports are exerting downward pressure on growth across the region, while moderate consumer demand is keeping domestic inflation negative. That said, we are generally constructive on Asia EM, but the virtuous cycle looks to be less robust than in Latin America.

The economies we cover in CEEMEA sit between these regions, both literally and figuratively. By and large, the region has also seen orthodox monetary regimes restrain inflation in recent years and, with a few exceptions, CEEMEA economies have combined that discipline with stable fiscal outlooks to support growth. South Africa is a prime example, where the central bank recently de facto lowered the inflation target to 3%Y from a range of 3-6%Y, reflecting growing confidence in low inflation. The restrained fiscal stance of the coalition government has reinforced the trend. The read-across for assets in fixed income and equities has been positive, and of note, we estimate that risk premiums have fallen as confidence has broadened.

Overall, we share the market’s bullishness on EM. We expect another solid year of growth ahead with limited fiscal and inflation risks. Heterogeneity will always exist … and therein lies part of what makes EM interesting. If there is a theme across EM underpinning the strong performance, it is the dollar. As the dollar weakens, it provides support broadly. Our baseline view is for the Fed to cut rates twice more this year and for the decline generally to continue. But persistently strong growth in the US means that if inflation does not start to show a downtrend in the next couple of months, those rate cuts will come into question, and with them, the outlook for the dollar.

More in the full Sunday Start note from Morgan Stanley available to pro subs.