The Middle East conflict has not only broken the multi-decade correlation between crude oil and emerging market currencies but has also driven their performance in opposite directions, with their correlation coefficient falling to its lowest level in at least 27 years. Driven by energy supply disruptions stemming from the Middle East conflict, Brent crude futures recorded their largest gain since 2020. Meanwhile, the MSCI Emerging Market Currency Index is heading for its steepest monthly decline since the end of 2024. This has driven the 120-day rolling correlation coefficient between the two to -0.34, the most negative value since data records began in 1999.
Historically, these two asset classes have been influenced by the same macroeconomic variables: global economic growth, commodity demand led by China, US dollar liquidity, and cross-border capital flows. Over the past 25 years, crude oil has experienced four multi-year bull markets with gains exceeding 200%—each time, the MSCI Emerging Market Currency Index rose in tandem, repeatedly reaching new record highs. Now, this pattern has been completely overturned. This year, propelled by supply disruptions exceeding those of the 1970s, oil has instead become a catalyst for risk-off trading and a flight to safe-haven assets. Investors have flocked back to US assets, selling off higher-risk positions in emerging markets. The result is that rising oil prices now often signal declines for emerging market currencies.
Grant Webster, Co-Head of Emerging Market Sovereign Debt and Foreign Exchange at Ninety One, stated that positioning is exacerbating the negative impact of oil prices on emerging market currencies. "The Middle East situation is pushing oil prices higher and dampening market sentiment, at a time when foreign investors' positioning in emerging market currencies was already elevated. Therefore, the decline in emerging market currencies stems partly from deteriorating terms of trade and is amplified by position unwinding and a broad sell-off in global risk assets," Webster explained.
On Thursday, the emerging market currency index fell 0.3%, bringing its cumulative decline for March to 1.4%; Brent crude surged 5.5% to $97.05 per barrel, putting it on track for a monthly gain of 34%.
The market structure has quietly changed. Until a decade ago, emerging markets were primarily dominated by commodity exporters. However, this landscape has long since shifted as technology firms and financial institutions have gained greater weight in benchmark indices. Similarly, the rise of net energy importers like India and Turkey has weakened the traditional link between their currencies and oil prices. The current concentration of geopolitical risks is boosting inflation expectations, delaying central bank interest rate cuts, and pushing US Treasury yields higher, ultimately driving the two asset classes completely apart and in opposite directions.
Webster believes investors need to wait for volatility in oil prices to subside before seeking opportunities in emerging market currencies. Economies that are net oil exporters, have low dependence on oil imports, and exhibit moderate inflation will be more favored. Conversely, economies highly reliant on oil imports or struggling with high inflation will face pressure.
However, Webster added, "I believe this volatility is temporary." Even if oil prices remain elevated, the market's volatility shock will eventually dissipate, and positioning will be cleared. At that point, investors can more strategically position themselves in currencies expected to benefit or suffer.