Emerging markets debt investment views – February 2026
EMD has begun 2026 strongly, with local currency bonds delivering notable outperformance while hard currency debt remains a high-income generator
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Emerging markets (EM) debt began the year on a very strong footing, as the positive macro-economic trends of the past three years continue to gain broader recognition among global asset allocators. Flows into EM debt funds remain robust, supported by still-appealing yields, a weaker US dollar, and the continuation of stable policy frameworks in most EM countries. These conditions should allow several EM central banks to credibly ease monetary policies further in 2026.
Against this supportive backdrop, EM local currency debt extended last year’s strong momentum, outperforming again in January, with the GBI-EM GD index (Government Bond – Emerging Market Index Global Diversified) rising by 2.2%. This outperformance is particularly notable given persistent upward pressures on long-dated developed market government bond yields and the renewed uncertainties surrounding the future path of the US monetary policy following the nomination of Kevin Warsh as the new Federal Reserve Chairman.
Despite EM sovereign and corporate spreads being at historically tight levels, most issuers continue to exhibit reasonably strong credit metrics, which allows EM hard currency debt to maintain price stability and remain a high-income generator. In this regard, the sector achieved a return of 0.7% in January, when measured by the EMBI GD index.
We have recently adopted a more cautious stance on the outlook for US interest rate duration by downgrading its overall score to neutral, as shown in Figure 1. This shift reflects the continued strength of US economy activity and the risk of further steepening of the US yield curve, particularly if markets begin to more firmly anticipate the potential implementation of the monetary policy mix (lower policy rates alongside quantitative tightening) seemingly advocated by the newly nominated Chair of the US Federal Reserve.
While we are not fully convinced that such a policy mix is feasible in an environment of fiscal dominance, there remains a risk that it is initially pursued before ultimately being questioned in response to market constraints. There will probably be a need for a regulatory overhaul to possibly incentivise commercial banks to absorb the supply of Treasuries and reduce the risk of a massive liquidity withdrawal.
Figure 1: Sectoral scorecard
Despite these uncertainties about the future path of US monetary policy, we take comfort from the fact that EM assets have been demonstrating for several months now that they have become well equipped to withstand various exogenous shocks. Our latest reviews of fundamental, quantitative, technical and sentiment factors are summarised in the scorecard shown in Figure 1. As can be seen, EM dollar high yield, local rates and currencies continue to screen very positively despite some deterioration in dollar debt and EM exchange rate valuations.
The positive outlooks for various EM debt sectors highlighted in the scorecard are notably due to:
Global economic activity remaining firm, which provides a supportive backdrop for EM assets. Moreover, while US growth expectations have rebounded strongly, the growth differential between EM and the US is still on average at levels that have historically been sufficient to sustain, and in many cases, attract new capital flows into EM assets (figure 2).
In addition, EM exports are also proving more robust than expected despite higher US trade tariffs. This EM export resilience is due to prospects of new trade pacts with India being the latest to reach an agreement with the US, expanding EM intra-regional trade, and ongoing re-routing of global supply chains. All these factors are helping to keep global trade activity at reasonably elevated levels despite some intermittent dips.
Figure 2: Global growth expectations
Source: Schroders; Consensus Economics; LSEG Data & Analytics – January 2026.
Inflation trends remain benign across most emerging market economies, supported by subdued food and energy prices and the strong disinflationary pressures still emanating from China and disseminated to several EM countries, especially those with lower trade barriers or limited export overlap with China.
As illustrated by figure 3, most EM countries have either accomplished a sustained peak in inflation or have moved firmly into a strong disinflationary phase of the cycle as we begin 2026. With these trends in place, EM policy rates still appear overly restrictive (figure 4), creating meaningful scope for further monetary easing across regions. This backdrop is particularly supportive for EM local bonds, especially in countries where debt dynamics are manageable and real yields remain excessive relative to fiscal risk premia (figure 5).
Figure 3: Stages of the inflation cycle by region and country
Source: Schroders – January 2026. For illustrative purposes only and not a recommendation to buy/sell. “Expectations” refers to average 12-month market consensus expectations.
Figure 4: EM inflation and real rates
Source: Schroders Economics Group; LSEG Data & Analytics – 31 December 2025. ¹18 Major EMs, equal-weighted.
Figure 5: Debt levels and real rates
Source: IMF, Macrobond, Schroders – December 2025.
While some pockets of overvaluation are starting to appear in some hard currency debt and foreign exchange markets, we are not overly concerned by this given the strong credit metrics that EM exhibits. These include substantial external buffers, significantly lower reliance on short-term foreign capital and the current early stages of the recovery in capital inflows into EM. Moreover, our actively managed EMD portfolios have been taking profits in some of less appealing hard currency debt markets in favour of several high real yielding local currency debt markets such as Brazil, Mexico, South Africa, Hungary, Egypt, Nigeria and Turkey.
Figures 6 and 7 show our full 2026 expected returns by sector and country versus our level of conviction based on the scores emanating from our investment process.
Figure 6: Local currency debt expected returns vs. investment process scores
Source: LSEG Data & Analytics, Schroders – 28 November 2025. ¹12 month expected returns combine the income accumulated over the next 12 months, the forecasted changes in 10-year bond prices and, in the case of local bonds, the returns from the currency are also included. The 12 months expected returns for currencies include the forecasted spot changes and the carry (implied yield) generated by the currency forwards. The expected returns are all expressed in US dollar terms, which would require the addition of the cost/gain of hedging of US dollar returns into other currencies for non-US dollar investors.
Figure 7: Hard currency debt expected returns vs. investment process scores
Source: LSEG Data & Analytics, Schroders – 28 November 2025. ¹12 month expected returns combine the income accumulated over the next 12 months, the forecasted changes in 10-year bond prices and, in the case of local bonds, the returns from the currency are also included. The 12 months expected returns for currencies include the forecasted spot changes and the carry (implied yield) generated by the currency forwards. The expected returns are all expressed in US dollar terms, which would require the addition of the cost/gain of hedging of US dollar returns into other currencies for non-US dollar investors.
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