Many currencies are no longer moving in tandem with the euro, boosting confidence in a sustained rally even as Europe staggers toward a long-term solution to its crisis.
The 25 currencies in the MSCI Emerging Markets Currency Index rose 4% in January, outperforming most other assets with the exception of stocks. That compares with a 1.8% increase in the euro's value against the dollar and a 2.2% rise in the Goldman Sachs Commodities Index. The Standard & Poor's 500-stock index advanced 4.3% last month.
Emerging-market bond funds pulled in $907 million during the week ended Jan. 25, the highest since August, according to data provider EPFR Global. Similarly, commitments to local currency bond funds also have returned to levels last seen in August, with $373 million in inflows in the week ended Jan. 25. Foreign investors frequently buy emerging-market debt denominated in local currencies as a way to gain exposure to both the bond's often high yields and the underlying currency.
In the final months of 2011, investors fled emerging markets for the safety of the dollar and U.S. Treasurys. They were worried that the euro zone was on the verge of splintering and that sovereign-debt defaults would trigger a global financial crisis.
Some investors said the pendulum is swinging more in favor of "decoupled" markets, betting that Europe's crisis won't inflict the kind of contagion witnessed across markets during the financial crisis in 2008-2009 or even at the height of concerns over Europe last year.
Ever since the 2008 credit crisis, when emerging markets quickly rebounded, the case for strong growth has overwhelmed fear of volatility, said David Creighton, president and CEO of Cordiant Capital, an investment company, focusing on emerging markets. "The appetite for [emerging markets] is better now than before," Mr. Creighton said. "There's a shift in realization that opportunities are in emerging markets while the Western world is in a state of confusion over the foreseeable future."
To be sure, some aren't convinced that all emerging markets have completely severed their ties to the euro-zone crisis.
"You could play these short-term trends and have your face ripped off," said Robert Abad, portfolio manager at Western Asset Management, referring to the sharp jumps in the Mexican peso and Turkish lira.
If the European crisis takes a turn for the worse, emerging-market currencies are likely to fall back in line with the euro.
"In the long run, [emerging markets are] decoupling," said Eric Fine, managing director of G-175 strategies at Van Eck Global, a global asset manager. But in the short term, "there's a lot of dry wood and a little spark could create a serious fire."
John Carlson, a portfolio manager at Fidelity Investments who oversees $5.6 billion in emerging-market assets, said he is wading back into bonds denominated in the Mexican peso and Turkish lira. But he is buying the debt largely to gain exposure to currencies he expects to perform well. "It's more of a currency view," he said of his investment.
The lira tracked the euro lower against the dollar throughout December. The currencies' 30-day correlation, a measure used to determine whether a pair moves in sync or not, frequently exceeded 0.90, indicating that their movements are closely tied. The number was 0.40 on Wednesday, meaning the two currencies are now effectively uncorrelated. The South African rand, Indian rupee and Mexican peso also displayed a similar break in their relationship with the euro.
The Turkish currency and Mexican peso both are up 6.6% against the dollar this year. The rupee hit a record low on Dec. 15 against the dollar, dropping more than 20% in four months. In January, it gained 8.6% from its low.
India's growth rate is projected to slow to 7%, from more than 8% last year. But that is well beyond even the most optimistic forecasts for Europe. Investors also are buying the rupee because of the country's low external debt, comfortable level of foreign-exchange reserves, and strong domestic demand and production.
"Many emerging-market investors had forgotten their convictions in 2011," said Jan Dehn, senior strategist and portfolio manager at Ashmore Investment Management, which manages $60.4 billion in emerging-market assets.
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