Emerging market debt: opportunities in a fragile world
June 2026 update: The global environment remains extremely challenging, but risks remain manageable for several EM economies.
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Our outlook for emerging market (EM) fixed income remains constructive, despite an exceptionally challenging global backdrop. Markets continue to face three major sources of risk, all of which are proving more persistent than many market participants and policymakers had initially expected:
- Persistent global trade tariff frictions and geopolitical shocks in the Middle East. In particular, uncertainty around the status of the Strait of Hormuz and the outlook for oil supplies from the Gulf are likely to keep global investors extremely nervous.
- Rising stagflationary headwinds across the global economy. Slowing growth momentum, combined with inflation pressures emanating from supply shocks, continues to complicate the policy outlook.
- Mounting fiscal fragilities in several developed countries, where increasingly fragmented political landscapes are making future fiscal consolidation elusive, which could maintain elevated fiscal risk premia in global bond markets.
If these three risks re-intensify, particularly at the same time, they could place significant pressure on global asset prices and would call for a highly defensive portfolio stance.
In this regard, a decisive break higher in long-dated US Treasury yields beyond their recent range would be an important warning signal. When this occurs, it may be time to raise cash levels and implement portfolio hedges. Encouragingly, US yields tested and rejected the top of this range in May, which has corroborated our positive technical and sentiment signals for this market.
Moreover, several factors support our view that the risks highlighted above can remain largely contained:
First, these global risks are now widely publicised and, as a result, appear to be at least partly reflected in market pricing. In EM (emerging markets), this is particularly evident in the significant washout in currency positioning, which has led to a welcome unwind of the excessive EM carry trades and speculative exposures that market participants rapidly accumulated during last year’s US dollar weakness (reminder: carry trades involve borrowing in a low interest currency and reinvesting in assets yielding higher returns).
Asia provides a clear example of this adjustment: consensus positioning in the region has recently reached extremely short levels, as shown in Figure 1, leaving it well placed for a sharp rebound should global tensions begin to ease.
Figure 1: Market consensus positioning – Asian currencies
Source: Schroders FX Survey, June 2026
Second, our measures of global monetary aggregates suggest that global financial liquidity remains ample, continuing to grow at levels that have historically been conducive to risk-seeking behaviour.
Third, and most importantly, recent developments have reinforced our conviction that the resilience of key emerging market economies remains intact. This resilience is supported by stronger macroeconomic fundamentals and more stable policy frameworks than we experienced in previous challenging growth and inflation cycles.
Figure 2 illustrates an emerging trend of global investors increasingly recognising the relative strength of EM fiscal and balance of payments metrics compared with developed markets. As can be seen, EM yields have been trending lower, while developed market (DM) yields remain subject to upward pressure.
Figure 2: EM and DM bond yields (%)
Source: LSEG DataStream, Schroders Economics Group, 28 May 2026.
Past performance is not a guide to the future and may not be repeated
Fourth, external accounts across much of the emerging world remain in good shape. Balance of payments positions are generally healthy, while foreign exchange reserve buffers provide an additional layer of protection against external shocks. As a result, the risk of widespread balance of payments crises or sudden funding pressures appears low. Despite ongoing global shocks, EM foreign exchange reserves continue to grow, as shown in Figure 3. Apart from Turkey and Indonesia, no other major EM economy has been forced to intervene heavily to stabilise exchange rates during the recent geopolitical shocks.
Figure 3: EM foreign exchange reserves - annual growth (%)
Source: Schroders, Bloomberg, LSEG Data & Analytics, 29 May 2026
Fifth, many emerging economies have an embedded geopolitical hedge thanks to their status as commodity exporters. In an environment characterised by geopolitical tensions, supply chain fragmentation and increased competition for strategic resources, commodity producing countries can benefit from higher export revenues and stronger external balances. Latin America stands out in this regard, which explains our strong recent focus on the region in the positioning of our EMD portfolios.
Brazil provides a compelling example. Despite recent bouts of global market volatility and domestic political uncertainty, Brazilian local government debt has delivered exceptionally strong returns this year, returning approximately 12% in US dollar terms as measured by the GBI-EM Global Diversified Brazil Index. This outperformance has been driven primarily by the appreciation of the Brazilian real, itself supported by several powerful fundamental factors: still reasonable real effective exchange-rate valuations, the highest real interest rates in the investable universe, a trade balance that continues to generate sizeable surpluses and limited dependence on short-term foreign capital flows.
The last point is particularly important. Foreign ownership of Brazil's domestic bond market remains near multi-year lows, at roughly 11% of outstanding debt, reducing vulnerability to abrupt capital outflows during periods of market stress. In our view, this combination of strong external accounts, attractive valuations and substantial real yield buffers provides significant protection against adverse shocks. As a result, despite the upcoming presidential election in October, which will inevitably generate periods of heightened volatility, we remain constructive on Brazilian local currency bonds.
Inflation risks are building globally, yet interest rate buffers remain significant
Figure 4: Current stage of the inflation cycle by country
Source: Schroders, May 2026. For illustrative purposes only and not a recommendation to buy or sell.
As shown in Figure 4, the rise in oil prices has generated renewed inflationary pressure across several developed and emerging economies, interrupting what had previously been a broad-based disinflation trend. While these inflation signals are starting to flash red across the board, four important differences stand out compared with the inflation shock that followed Russia's invasion of Ukraine in 2022, which subsequently had a severe impact on global and EM bond markets.
First, the starting point for the current uptick in inflation across most emerging economies is significantly lower compared to the energy shock of 2022. Second, the current oil supply shock is occurring against a backdrop of muted global demand, unlike in 2022, when the global economy was still experiencing a post-COVID demand surge and widespread disruptions to manufacturing supply chains. Third, current inflationary pressures are emerging in the context of already historically tight monetary policy and elevated real interest rates, giving policymakers greater room for manoeuvre. Fourth, emerging markets are no longer moving in lockstep, either in terms of market performance or policy reactions to market shocks or to renewed price pressures.
In this regard, countries such as South Africa have been rewarded by investors for acting decisively with a rate hike in May designed to preserve policy credibility and maintain adequate real rate buffers. Markets have been less forgiving for countries such as Indonesia, where policy signals have been erratic and fiscal credibility has deteriorated. The Indonesian rupiah has continued to weaken, forcing the central bank to implement a rate hike in May that has so far failed to reassure the market.
By contrast, several other major emerging economies, including Brazil and Mexico, have recently demonstrated their ability to cut interest rates in response to softer growth dynamics. This has been well received by markets, as evidenced by the continued appreciation trend of their currencies.
This divergence across countries reinforces the importance of active management and country selection in navigating the current stagflationary headwinds. Figure 5 is an illustration of the performance dispersion experienced so far this year in the EM local fixed income universe.
Figure 5: Year-to-date return of EM local bonds and currencies (%)
Source: Bloomberg, JP Morgan, 3 June 2026
We expect current differences in valuations to amplify this dispersion in EMD performance over the rest of the year.
Valuations across the EMD universe are increasingly dispersed
Within hard currency sovereign debt, investment-grade bonds appear expensive. Credit spreads have compressed significantly in this subsector to 90 basis points (bps), which offer limited compensation for potential downside risk, particularly in a world where developed market bond yields can be subject to renewed volatility.
In contrast, pockets of value remain available within the high-yield segment of the hard currency universe, which still offers spreads in excess of 400 bps based on the EMBI GD Index. While careful credit selection remains essential, investors can still find attractive risk adjusted opportunities among issuers enjoying improving fundamentals, but whose valuations have not fully reflected this progress. Several sovereign oil credits in Africa, such as Nigeria and Angola, continue to exhibit improving credit metrics and a favourable policy trajectory.
Our strongest conviction remains in local currency debt. Local rates continue to offer some of the most attractive opportunities across global fixed income markets. 10-year government bond yields in Brazil (14.5%), Colombia (12.3%), Mexico (9.1%) and South Africa (8.6%) are among the local bond markets whose yields, in our view, more than compensate investors for current inflation and geopolitical risks.
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