Emerging markets debt investment views - August 2025
We provide an update on our latest asset class views and discuss the outlook for EM currencies and the US dollar.
Authors
The recent trade agreements between the US and several developed and emerging countries have helped ease concerns over the possible start of a broad-based, tit-for-tat trade war. As trade-related uncertainties have diminished somewhat and market fear over the Middle East situation has subsided, global growth expectations have begun to be revised upward.
This relief on economic growth, combined with highly accommodative global financial liquidity conditions, has fuelled a broad-based rally in risk assets since the market scare of Liberation Day on 2 April. Emerging market (EM) assets, which had already been delivering strong performance prior to the de-escalation in the trade war, have received an additional boost from this more supportive global environment.
However, a critical question now arises: have the strong year-to-date gains of EM debt led to a deterioration in valuations and positioning indicators that could begin to act as headwinds for the asset class? Our short answer: while a period of short-term consolidation in EM currencies is possible, the fundamental conditions supporting continued strong performance in EM bonds - both hard currency and local currency - remain firmly intact.
In EM dollar-denominated debt, the difference in yields compared to less risky bonds is now the smallest it has been in years, yet we continue to see meaningful pockets of value in the high yield sub-sector. Meanwhile, EM local currency rates remain appealing given historically high real (inflation-adjusted) yields, especially given expectations of contained EM inflation, abundant domestic liquidity in several EMs, and early signs of a recovery in foreign inflows to EM local bond markets.
We remain of the view that the cyclical downturn in the US dollar has been firmly established. However, with market participants appearing to have recently turned overwhelmingly bearish on the greenback, a short-term correction in positioning may be necessary before the dollar can resume its weakening trend. Below, we provide a brief update on the long-term outlook for the US dollar and our expected trends for EM currencies.
More broadly, our current views are reflected in our sectoral scorecard in Figure 1. As can be seen, EM local rates remain our top sector pick given the attractive 10-year government bond yields still on offer: 14% in Brazil, 12% in Colombia, 9.7% in South Africa, 9.3% in Mexico, 7.1% in Hungary, and 6.4% in both India and Indonesia.
Figure 1: Sectoral scorecard
Note: Interest rate duration refers to US rates performance. EM dollar debt IG forecasts investment grade hard currency debt, while EM dollar debt HY forecasts non-investment grade hard currency debt. Investment grade bonds are the highest quality bonds as determined by a credit rating agency. High yield bonds are more speculative, with a credit rating below investment grade. EM local rates forecast EM local currency bond prices, and EM currencies forecast EM currencies versus the US dollar.
Figure 2: Global real broad money growth %
Source: Bloomberg, Schroders, 30 June 2025. 615837.
Global financial assets have been undoubtedly turbocharged since the market scare of Liberation Day by favourable market technical conditions (short covering rallies) and, more importantly, by the strong growth in global monetary aggregates (i.e. measures of the total sum of money in the economy) highlighted in figure 2. This resurgence in global liquidity has also been reflected in the recent strong growth of EM foreign exchange reserves, the recovery of flows into EM local bond markets and a strong rebound of foreign capital flows to US financial markets.
While these favourable trends are expected to remain firmly in place, they are probably due for what could be a (summer) seasonal pause. We are already seeing evidence of this consolidation in EM currencies, which have started to experience what we believe to be a short-term correction.
Figure 3: Sentiment indicator – consensus positioning in currencies
Source: Schroders (based on a survey of banks by Schroders' fx dealers, 4 August 2025. 615837.
Nevertheless, we have been reassured so far by the ability of EM currencies to absorb relatively well the recent shocks created by US tariffs announcements. From a fundamental standpoint, these tariffs are likely to impact EM exports to the US to some degree. Nonetheless, most EMs maintain solid balance of payments positions, which should allow them to absorb this expected deceleration in US import demand.
Furthermore, higher inflation differentials between the US and the rest of the world (that could be exacerbated by the tariffs) are expected to alleviate the recent erosion in EM real effective exchange rate (REER) valuations. The REER shows how the value of a country’s currency compares to currencies of major trading partners.
China has already provided the most striking example of this: the renminbi has experienced a marked improvement in valuations, underpinned by a 17% decline in its REER over the past three years (figure 4).
Figure 4: China – real effective exchange rate
Source: Schroders, Bloomberg, LSEG Data & Analytics, Macrobond, 31 July 2025. 615837.
In contrast, despite the US dollar weakness so far this year, its real effective exchange rate remains approximately 12% above long-term average (figure 5). We continue to hold the view that the cyclical downtrend in the US dollar will reassert itself. This outlook is supported by the unsustainably high levels of the US twin deficits and the country’s increasing dependence on external financing, at a time of increasingly erratic US policy interventionism.
Figure 5: US dollar real effective exchange rate
Source: Schroders, Bloomberg, LSEG Data & Analytics, Macrobond, 31 July 2025. 615837.
Authors
Témák