U.S. Dollar Weakness and Sino-U.S. Trade Tensions: Tactical Asset Allocation Shifts in Emerging Markets

The U.S. dollar's historic decline in 2025-its worst first-half performance in over 50 years-has reshaped global investment strategies, particularly in emerging markets. According to a Morgan Stanley report, the DXY index fell 11% from January to June 2025, driven by Trump-era tariffs, policy uncertainty, and a global de-dollarization trend. This weakening has accelerated capital reallocations, with investors pivoting toward emerging markets to hedge against dollar volatility and exploit growth opportunities amid Sino-U.S. trade tensions.

The Dollar's Decline: A Catalyst for Rebalancing

The U.S. dollar's weakness stems from a confluence of factors. The Trump administration's aggressive tariff policies, initially expected to bolster inflation and the dollar, instead created uncertainty, triggering capital outflows and eroding investor confidence, according to Pathstone's April 2025 report. By September 2025, the DXY had fallen to 97.55–97.70, with analysts projecting further depreciation as U.S. interest rates converged with global benchmarks, the Morgan Stanley report found. Compounding this, the dollar's ranking in central banks' preferred currencies dropped to seventh, while the euro and yuan gained traction, a trend noted in Pathstone's analysis.

Policy volatility has further pressured the dollar. A controversial remark questioning the independence of the Federal Reserve led to a 1.2% single-hour drop in the currency, according to a Federal Reserve note. Meanwhile, the Fed's projected rate cuts in 2025-aimed at mitigating inflationary pressures-have compounded downward momentum, the Morgan Stanley report observed. These dynamics have prompted foreign investors to hedge U.S. asset exposure, accelerating capital outflows to emerging markets.

Tactical Shifts in Emerging Markets

Investors are rethinking traditional emerging market strategies, particularly by decoupling China from broader EM allocations. As noted by a Goldman Sachs analysis, China's economic fundamentals-shaped by regulatory crackdowns, demographic challenges, and a property sector crisis-now diverge sharply from other EMs. This has led to a strategic reallocation toward markets like India, which benefits from structural reforms, nearshoring trends, and favorable demographics, a point emphasized by Goldman Sachs.

Regional and sectoral shifts are also evident. Invesco's October 2025 tactical asset allocation report emphasizes an overweight in fixed income and quality assets, while underweighting the U.S. dollar. Specific regional allocations favor India, Japan, and the Philippines, which are less exposed to U.S. tariffs and exhibit stronger domestic demand, according to Cambridge Currencies. Conversely, countries like Vietnam, Taiwan, and South Korea face heightened vulnerability due to their integration into U.S.-China supply chains, a risk noted in broader USD forecasts.

Currency diversification has become a cornerstone of tactical strategies. With the dollar weakening against the euro (forecasted to reach 1.08 by Q4 2025) and the yuan, investors are increasingly hedging against dollar volatility by allocating to local currencies in EMs, a trend discussed by Goldman Sachs. This trend is supported by the Federal Reserve's acknowledgment that 50% of international payments still use the dollar, but its dominance is eroding, the Fed note explains.

Sectoral Reallocation and Risk Management

Sectors less sensitive to U.S. trade policy are gaining traction. For example, technology and consumer discretionary sectors in India and Southeast Asia are attracting inflows as companies seek to diversify supply chains away from China, a point highlighted by Goldman Sachs. Conversely, sectors like manufacturing and export-dependent industries in tariff-exposed regions are being scaled back, consistent with USD forecast analyses.

Fixed-income strategies are also evolving. Pathstone's April 2025 report recommends shifting to short-duration bonds and cash to manage liquidity risks amid heightened uncertainty. This aligns with broader defensive positioning, as global risk appetite contracts and inflation expectations remain volatile, observations echoed in the Morgan Stanley report.

Conclusion: Navigating a Fragmented Landscape

The U.S. dollar's weakness and Sino-U.S. trade tensions have created a fragmented global investment landscape. Tactical asset allocation in emerging markets now hinges on active management, regional selectivity, and currency diversification. As the dollar's long-term pressure persists, investors must prioritize resilience over broad exposure, leveraging opportunities in EMs with structural strengths while hedging against geopolitical risks.