Rising hedge fund leverage and crowded investment positions could amplify financial instability across emerging markets, as weakening global risk appetite and renewed monetary tightening trigger capital outflows, according to analysis by Research Fellow Iván Weigandi.

Emerging markets have demonstrated resilience throughout much of 2026 despite higher global interest rates and energy price volatility, supported by strong equity valuations and investor optimism surrounding artificial intelligence. Foreign investors allocated $246bn to emerging market bonds between January and September, partially offset by $114bn in equity outflows, while emerging market currencies appreciated 4.2% against the US dollar.

However, sentiment deteriorated sharply in September as expectations of further US monetary tightening pushed Treasury yields higher. Non-resident portfolio flows reversed from $11.4bn of inflows in August to $26.3bn of outflows in September, while emerging market currencies weakened 3% against the dollar. Sovereign, corporate and high-yield credit spreads widened by 35, 41 and 85 basis points respectively from 10 September.

The analysis identifies growing leverage among hedge funds and other non-bank financial institutions as a potential source of market disruption. Highly leveraged portfolios and concentrated positions could accelerate selling during periods of volatility, with margin calls forcing investors to liquidate emerging market assets and intensifying pressure on currencies and bond markets.

An AI-related market correction presents another significant risk, particularly for technology-exposed economies including South Korea, Taiwan, Malaysia and Vietnam. Further oil price shocks could also weaken emerging market financing conditions, especially among net energy importers already facing higher import costs and foreign currency pressures.

The report warns that the combination of leveraged investment strategies, interconnected financial markets and deteriorating global risk appetite could leave emerging economies exposed to further capital flight, despite improvements in domestic economic fundamentals.