Decades-long pattern broken! Middle East conflict completely "tears apart" the trends of crude oil and emerging market currencies.

The situation in the Middle East has not only broken the long-standing relationship between oil and emerging market currencies for decades, but has also completely reversed their trends, with the correlation dropping to the lowest level in at least 27 years. Impacted by the energy supply shock triggered by the Middle East conflict, Brent crude oil futures have seen the largest increase since 2020. At the same time, the MSCI Emerging Markets Currency Index is heading towards its most devastating monthly decline since the end of 2024. This has reduced the 120-day rolling correlation between the two to -0.34, the largest negative value since data has been collected in 1999. Historically, the trends of these two asset classes have always been influenced by the same macro variables: global economic growth, China-led demand for commodities, US dollar liquidity, and cross-border capital flow. Over the past 25 years, there have been four bull markets in which oil prices have surged by over 200% each time, the MSCI Emerging Markets Currency Index has risen in tandem, hitting historical highs. Today, this pattern has been completely rewritten. This year, due to the supply disruptions surpassing those of the 1970s, oil has become a catalyst for risk aversion trading, prompting funds to flow towards safe assets. Investors are flocking back to US assets, selling off high-risk positions in emerging markets. As a result, an increase in oil prices often means a decrease in emerging market currencies. Grant Webster, Co-Head of Emerging Market Sovereign Debt and Foreign Exchange at Ninety One, stated that portfolio structures are exacerbating the negative impact of oil prices on emerging market currencies. "The situation in the Middle East is driving up oil prices and dampening market sentiment, while foreign investors are already holding significant positions in emerging market currencies. Therefore, the decline in emerging market currencies is partly due to deteriorating trade conditions and is magnified by position unwinding and broad-based selling of global risk assets." On Thursday, the Emerging Markets Currency Index fell by 0.3%, widening the March decline to 1.4%; Brent crude oil surged by 5.5% to $97.05 per barrel, with a potential monthly increase of 34%. Market structure has quietly changed Until a decade ago, emerging markets were mainly dominated by commodity-exporting countries. But with the increase in the weighting of technology companies and financial institutions in benchmark indices, this landscape has already changed. Similarly, the rise of energy net importers such as India and Turkey has also weakened the correlation between currencies and oil prices. With geopolitical risks erupting, driving up inflation expectations, slowing down central bank rate-cutting cycles, and pushing up US bond yields, the two asset classes will ultimately be "torn apart," moving in completely opposite directions. Webster believes that investors should wait for oil price volatility to settle down before looking for opportunities in emerging market currencies. Economies that are net oil exporters, have low oil import dependence, and moderate inflation will be more favored. Conversely, economies that are highly reliant on oil imports or have high inflation will come under pressure. However, Webster added, "I believe this volatility is temporary," even if oil prices remain high, the market's shockwaves will eventually dissipate, and positions will be cleared out. At that time, investors will be able to strategically position themselves in currencies that benefit or are harmed.