US international debt has ballooned to over $26 trillion, is now showing clear signs of peaking.
A seismic shift is underway in global capital markets. The extreme concentration in US assets, a phenomenon driven by fiscal policies that ballooned the $US international debt to over 26 trillion, is now showing clear signs of peaking. Emerging markets specialist Ashmore believe the powerful tailwinds that lifted US equities are abating, setting the stage for a rotation into other markets.
Several catalysts are accelerating this transition. Externally, stronger growth outlooks in key economies such as Germany and China are increasing their appeal. Internally, the necessary move to tackle the US fiscal and current account deficits will likely pressure the dollar and domestic earnings, prompting global investors and central banks to look elsewhere.
The large US fiscal and external imbalances mean the US dollar is no longer the ‘safe haven’ it once was. While it is likely to remain the largest currency in reserve manager portfolios and trade/capital account settlements, the weight in other currencies will increase due to settlement alternatives and diversification.
This creates a historic opportunity for emerging markets (EMs). Many EMs now present a compelling investment case with strong fundamentals, high real yields and significant growth potential. As the global portfolio rebalances and de-dollarisation gains momentum, EMs are primed to capture substantial new inflows, potentially driving a new era of outperformance.
The inconvenient truth
There is a clear disconnect between the narrative and the reality behind US exceptionalism. The narrative is well known. Despite no longer being the single dominant force in global trade and economics, the US remains a leader through its reserve currency. Its world-beating education sector, openness to talented immigration and dog-eat-dog capitalism have also kept the US at the cutting edge of innovation, where its great minds have built the world’s leading technology companies, and its most advanced weapons. Both are difficult to replicate.
Nevertheless, all this has been part of the greatness of America for a century. During this period, the dollar has had major peaks and troughs, and US equities and fixed income valuations have traded at a wide premium to global assets, and sometimes, even, at a discount. What has driven US assets, particularly equities, to historic valuation premiums in the last decade has not been its century-old structural advantages, but additional macro forces.
The outperformance of the US in recent years has been underpinned by the shale oil revolution and the large pro-cyclical fiscal stimulus since Donald Trump’s first term. However, the magnitude of the imbalances within the US government budget will now make it very difficult for the US to keep sustaining the macro environment that has led to its equity market exceptionalism. Further fiscal expansion may bring unsurmountable macro imbalances and higher bond yields, which are likely to destabilise financial markets. Fiscal consolidation is now the only lucid policy direction to follow, in Ashmore’s view. However, this would directly hit US companies’ earnings.
The sharp increase in US equity market volatility corroborates this policy conundrum. This year, US stocks had a 20% drawdown and the fastest recovery on record, associated with the 2 April reciprocal tariff announcement and various stages of capitulation since.
Where to re-allocate
Some strategists claim US stocks are a better place to invest than bonds, as in their view, the government is unlikely to consolidate its gargantuan fiscal deficit. As the argument goes, large deficits keeping nominal GDP growth elevated would be a positive environment for stocks, particularly for high-quality companies, like the ‘Magnificent Seven’, which are better equipped to pass inflation through to prices and thus benefit from ongoing fiscal largesse.
History shows, however, that equities are not always a good inflation hedge. From 1968 to 1978, US stocks underperformed bonds meaningfully as inflation rose from 3.0% to average 6.5% over the period, with a high of 12.3% in 1974.
Gold (+201%), real estate (+14%), and BBB bonds (+4%) held their ground well during this decade (1968-1978). Ten-year bonds sold off by 16%, but the S&P 500 was down 28% and small caps dropped 40%. The S&P 500 and small caps had huge drawdowns of 40% and 80%, respectively from 1968 to 1974, as shown in figure one.
The recent surge in bond yields threatens market stability, particularly in high valuation stocks. It represents declining confidence in fiscal trajectories, exacerbated by the surge in interest expense due to rising global debt stock. Low valuation equities in the rest of the world (figure two), with earnings predominantly in currencies that are not being debased, represents a much better bet, with risk skewed to the upside.
Who holds most US assets?
a. Private vs. official sectors
The US is the largest net debtor country in the world, by far. Its net liabilities to the rest of the world have reached USD 26 trillion, equivalent to 88% of US GDP. This comprises USD 62 trillion of foreign ownership of US assets (a liability for the US) against USD 36 trillion of US investments abroad (an asset for the US).
In the last 20 years, the private sector has been increasing exposure to the US and today controls the lion’s share of portfolio investments. The ratio of private to official owners of US assets has increased five-fold from 1.5x in 2009 to 4x in 2024, with assets rising from around USD 5trillion to USD 25 trillion. This means that just a 5% reduction of US asset exposure by foreign investors would amount to USD 1.25 trillion of outflows at current valuations.
b. Europe
Europeans now hold USD 14 trillion in US portfolio assets, of which, USD 9 trillion is in equities. The improving European investment outlook and deteriorating US outlook should drive significant reallocation of capital back to Europe.
The majority of US equity exposure is unhedged, since the dollar would typically strengthen in a risk-off environment. Nevertheless, this relationship has changed in 2025 (see US dollar analogy later in this article), leading many EU investors to hedge their exposure.
It is conceivable there will be significant repatriation flows from European investors. This will be supported by the large fiscal expansion leading to significant investment opportunities in European equities as well as more issuance of high-quality European debt as well as a historically cheap euro. This would likely drive significant US capital account outflows.
c. Asia
Asian countries that have run large current account surpluses with the US over recent years have built correspondingly large holdings in US assets, as these surpluses have largely been recycled back into US stocks and bonds. Asian investors have a more conservative investor profile (as more of the assets are held by the official sector), with close to 55% of their USD 9 trillion of US exposure in bonds.
China and Japan still have by far the largest US holdings, even though Japan has trimmed its bond holdings in recent years. The raw data suggests China has been a seller of US assets, but it is assumed some of China’s UST holdings are now held in Belgium and Luxembourg, the domicile of Clearstream and Euroclear.
In nominal terms, but particularly in relation to the size of their domestic economies, South Korea and Taiwan now have significant positions in US assets. Korea holds USD 750 billion in US stocks and bonds, 40% of its GDP. Taiwan holds USD 820 billion of US assets, 105% of its GDP. Notably, USD 664 billion of this position is in bonds, which makes Taiwan the largest holder of US bonds in the world relative to the size of its economy. The recent spike in the TWD as investors began to speculate on the repatriation, or at least hedging, of some of this position demonstrates how significant a shift in positioning from Taiwanese investors could be for foreign exchange (FX) markets.
It is also well known that several Asian exporters have been hoarding dollars, as it gave them a higher yield than local currency and, until recently, a weakening JPY and RMB kept their currencies under pressure. With the recent strengthening of the JPY, most Asian currencies including the TWD, KRW, MYR and RMB, started to rise as well. This is likely to trigger significant rebalancing of investor and corporate currency exposure.
Institutional policies
Several narratives and facts are likely to drive a multi-year diversification away from US assets and the dollar.
- The weaponisation of the US dollar payment system via sanctions is encouraging neutral and non-aligned countries to seek alternatives.
- Geopolitics: Escalation of conflicts that force the US to spend more on defence (Ukraine, Israel) have been driving central banks to diversify out of US Treasuries.
- Less open economy: Barriers for trade, education, and immigration – as well as forcing US companies to manufacture in the US – will lead to higher prices and lower margins. Less immigration and more deportations will lead to lower potential growth and add inflationary pressures, particularly for low value-add services, construction, and manufacturing industries. The ongoing struggle with Harvard University is likely to push students towards universities in other countries.
- Institutions and the rule of law: Trump has threatened to sack Federal Reserve Chair Jerome Powell, has accused large legal firms of being partisan, and has installed close aides across key establishments, including the Supreme Court. Ashmore believes the US institutional decay predates Trump. There has long been a partisan schism leading to a severely dysfunctional Congress, which has been increasingly dominated by interest groups (i.e., lobbyists for various industries such as weapons, pharma, and tech). Congress has become increasingly transactional, leading to a more ineffective government balance.
- Foreign policy: The current administration’s bashing of key allies such as Europe and opponents like China, means these governments are mobilising to become more self-sufficient. Foreign investors thus have more opportunities to invest at home and to fear a less friendly US administration.
- Poor infrastructure: Investors betting on another decade of technology stock hegemony are missing a bigger point. There is no AI scaling without a massive increase in energy generation and heavy investment on the energy grid to support transition and distribution. The overload blackouts in Portugal and Spain last month, and the UK paying for energy generation companies to stop producing attractively priced wind renewable energy in the North Sea, shows the world is neither ready for the energy transition nor for an increase in energy demand. The next big equity investment opportunities, therefore, are likely to be in project finance. This is a space where Japan, Germany, and China outperform the US.
- External imbalances: The US current account deficit, excluding oil, is at a record high of 5% of GDP.
- Dollar settlement: Since the US is energy self-sufficient, exporting countries’ surplus have relocated to other places such as China, Europe, Japan and India. Even though oil is still priced in dollars, China has been successful at settling oil imports in RMB. This means oil exporters need to make an active decision to invest their surplus in the US. As the US has been actively debasing its currency since the pandemic, reserve managers have been prioritising gold. But the dollar has still been the leading currency for settlement, given the lack of alternatives. Not anymore. The BIS and the BRICS have been working on cryptocurrency projects (mBRIDGE and BRICS Pay) that could bypass the dollar system[1]. BRICS Pay is interesting as it is a crypto currency partially backed by gold and a basked of BRICS currencies, making it a good candidate for settlement and reserve assets.
- US rebalancing: Imbalances do not mean that things will change. But the US administration is openly very keen to lower the external imbalance of a historical high current account deficit. Scott Bessent, United States Secretary of the Treasury is encouraging Europe and Japan as they implement policies that are leading to a strengthening of their own currencies. This is where the fiscal policy is key. Bessent understands there will be no external rebalancing without an increase in the US savings rates (lower fiscal deficit) and a simultaneous lowering of Chinese and German savings.
- Foreign rebalancing: The fiscal expansion in Germany guarantees lower savings rates and more recycling of Northern European surplus. China is perhaps waiting for the US to show it is serious about lowering its fiscal deficit before attempting to support more consumption. After all, moving from an export-led to a consumption-led growth model is a major challenge. If the US does not rebalance its fiscal deficits, its external accounts will also remain imbalanced. In this scenario, higher tariffs on China would lead to a lot of re-routing, but China would retain its position as the largest exporter in the world and the US the largest importer, even if the bilateral trade declines.
Correlations breaking down: From the ‘dollar smile’ to the ‘dollar frown’
Another factor that should make it evident the US leadership position is eroding is the breakdown of the ‘dollar smile’ relationship. This elegant and simple model was created by then-Morgan Stanley currency strategist Stephen Jen. He posited that the dollar would strengthen both during periods when the US economy is outperforming the rest of the world, but also during a risk-off recessionary shock. The dollar could only weaken when the rest of the world’s growth was outperforming the US, in a benign macro backdrop.
An analysis of the mechanics of the model explains why it broke down in 2025. Anti-fragile currencies that benefit from recessions are those from countries that are net creditors to the rest of the world, like Switzerland or Japan. In a recession or severe risk-off events, Japanese and Swiss managers are forced to cut risk in their portfolio, which can be achieved either by selling foreign assets to buy local assets or hedging the FX exposure of foreign assets. Both flows drive the CHF and JPY stronger.
The US dollar, however, is a currency of the largest net debtor in the world. The dollar smile only worked since Alain Greenspan’s tenure (when the Fed started to promptly react to market volatility) because foreign investors would buy more ‘risk-off’ US Treasuries than they would sell ‘risk-on’ US equities, leading to an inflow to the US capital account that strengthened the dollar. But with inflation above the Fed’s target and severe question marks posed by tariffs, the Fed is not currently likely to cut rates in response to market volatility.
The simple logic of mean reversion suggests that no trend lasts forever – and the extraordinary outperformance of US equities is no exception. For years, a massive global concentration in US assets has been fuelled by fiscal expansion, pushing the nation’s net international investment liability to an unprecedented 26 trillion.
Since the change in the US administration last November, there have been seen signs of a pivotal shift. Abroad, renewed growth prospects in Germany and China—two of the US’s largest creditors—are creating attractive alternatives for investment. At home, the inevitable focus on reining in the twin deficits threatens to pressure US earnings and the dollar, further encouraging diversification.
This environment creates powerful tailwinds for emerging markets. The sheer scale of global exposure to the US means that even a minor rotation can have a major impact on the comparatively smaller EM capital markets. With their compelling combination of attractive valuations, high real yields, and improving fundamentals, emerging markets are well-positioned to capture the coming wave of inflows from investors seeking value, growth and diversification away from the dollar.
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Notes:
[1] https://www.bis.org/about/bisih/topics/cbdc/mcbdc_bridge.htm
Important information: The information included in this article is provided for informational purposes only. Sources for the material contained in this article are deemed reliable but cannot be guaranteed. We do not represent that this information is accurate and complete, and it should not be relied upon as such. Any opinions expressed in this material reflect our judgment at this date, are subject to change and should not be relied upon as the basis of your investment decisions. All reasonable care has been taken in producing the information set out in this article however subsequent changes in circumstances may occur at any time and may impact on the accuracy of the information. Neither Ashmore Investment Management, PAN-Tribal Asset Management Pty Ltd, their related bodies nor associates gives any warranty nor makes any representation nor accepts responsibility for the accuracy or completeness of the information contained in this article.
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