Emerging market debt investment views – May 2025
Appealing valuations and reduced macroeconomic vulnerabilities continue to support local emerging market debt, while the weaker US dollar provides a further boost.
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Emerging markets (EM) debt continues to show a remarkable resilience in the face of the current global trade and growth uncertainties. While hard currency debt ended the extremely challenging month of April only down -0.2%, EM local currency debt continued its strong rally by gaining +3.25% during the month thus taking the year-to-date return of the GBI EM GD index1 to +8.2%. Half of this return was generated by currency appreciation and the other half was almost equally split between bond price appreciation (lower EM local rates) and income generation.
This outperformance of EM local currency debt was supported by the long-standing appealing valuations of this sector and the low macro-economic vulnerabilities that several EM countries have been exhibiting.
EM local debt has also now started to be boosted by US dollar weakness and by what appears to be a tentative start of a rotation of global capital flows away from the US and in favour of the rest of the world. EM capital repatriations have equally gained some attention as evidenced by the example of Taiwan, where the currency has come under intense appreciation pressures because of life insurers trimming their gigantic US dollar holdings.
EM local rates and currencies remain our sectorial top picks, as shown in figure 1. After having shown a remarkable resilience to the recent upward pressures on US Treasury bond yields, we expect the downtrend in EM rates to regain traction. EM real yields (i.e. yields adjusted for inflation) remain close to multi-year highs at a time when growth expectations are deteriorating and EM inflation remains well behaved, especially following the recent drop in oil prices. This, combined with currency strength, should provide several EM central banks with more room to ease monetary policy.
In contrast, we are more cautious on EM dollar debt as our expected recalibration higher in sovereign spreads may have further to go to reflect the deterioration in growth expectations and the weakness in oil prices that could maintain pressures on oil related names. In this regard, we returned last month from our research trip to Nigeria with a more cautious view despite the encouraging reforms implemented since the election of President Tinubu in 2023.
Figure 1:
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.
The ongoing extreme uncertainties about trade tariffs have already started to affect global growth expectations. Revisions lower started for EM in the immediate aftermath of the 2024 US election. These revisions are also now affecting the US more significantly (figure 2) which has encouraged us to maintain a constructive interest rate duration view, reinforce our bullish EM local rates stance and gain increasing conviction that the US dollar bull cycle is now complete.
We believe that the ongoing trade war and the changes in the US policy frameworks have created the conditions for a structural reversal in global capital allocation away from US assets. While the US dollar reserve currency status is unlikely to be seriously challenged in the foreseeable future, we expect a rebalancing in global capital flows to lead to a cyclical US dollar downturn.
After years of global asset allocators being severely underinvested in EM fixed income, EM local currency debt is particularly well positioned to benefit from this rebalancing. The strong performance of the asset class in the face of the global dislocations experienced this year is undoubtedly starting to attract attention. A more detailed analysis of the potential of a rebalancing in global capital flows and the positive impact on EM local fixed income will be published later this month.
Figure 2:
1Government Bond Index-Emerging Markets Globally Diversified
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