Emerging markets debt investment views – June 2025
We provide our latest 12-month outlook as well as an update on Argentina following a recent visit.
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Emerging markets (EM) fixed income continues to deliver strong performance in 2025, driven primarily by local currency debt. This outperformance is underpinned by a combination of high-income generation, lower EM interest rates, and strengthening currencies. The asset class has been further supported by favourable domestic macroeconomic conditions across several EM countries, contained inflation, attractive valuations, and a supportive global liquidity environment.
Among the various EM debt sectors, local rates and currencies remain our top conviction, as illustrated in Figure 1. Despite the strong performance that has already been registered year-to-date, we believe there is still considerable upside potential.
In this monthly update, we reassess some of the key factors supporting this attractive outlook and present our updated 12-month expected returns by market, along with our conviction levels. We also provide an update on Argentina after a recent research trip.
Figure 1: Sectorial scorecard – our view on EM debt sectors
Note: Interest rate duration refers to US rates performance. EM dollar debt IG refers to investment grade hard currency debt, while EM dollar debt HY refers to 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 refers to EM local currency bond prices, and EM currencies refers to EM currencies versus the US dollar.
While EM local currency debt has outperformed this year, EM dollar-denominated debt has also regained traction in recent weeks, supported by some easing of pressures on US Treasury bond yields, growing evidence of global growth resilience to recent disruptions, and the recent outflows experienced by EM hard currency debt funds appearing to have abated.
Encouraging outlook for Argentina
Argentina is an example of a country where sovereign dollar debt experienced a brief correction in April before resuming its strong uptrend in May.
We returned from our recent research trip to Argentina with a confirmation of our positive outlook. Indeed, President Milei continues to enjoy strong popularity and stands a solid chance of achieving a favourable outcome in the upcoming mid-term elections (October 2025), especially given the weakness of opposition parties, which are either in decline or embroiled in internal conflict.
Despite his polarising persona, President Milei has sustained high approval ratings and continues to succeed in delivering economic stability notably thanks to a shock therapy that quickly restored fiscal and current account sustainability (figure 2).
Figure 2: Argentina Fiscal and Current Account Balances (% GDP)
Source: Schroders, LSEG Data & Analytics – 30 April 2025.
While these adjustments are still in progress, Argentina’s economy is showing a strong recovery this year, underpinned by a firm commitment to fiscal discipline, ongoing efforts to curb inflation, and gradual progress toward easing restrictions on cross-border capital flows. However, the strong focus on disinflation, notably by maintaining the overvaluation of the currency, has delayed the much-needed international reserves accumulation, which remains the weak spot in the ongoing adjustment programme.
We take comfort from the fact that strengthening political capital could allow the administration to advance a pro-growth agenda more forcefully over its final two years, supporting investment and bolstering international reserves.
We remain particularly constructive on the country’s dollar-denominated debt which still offers 10-year yields of 11%. That said, we are closely watching the evolution of external accounts and the foreign exchange dynamics, as the currency has become extremely overvalued. While Argentina’s local government debt also offers attractive real yields, we currently favour dollar denominated debt due to the potential for currency volatility.
Four reasons why EM local currency debt can continue to outperform
Elsewhere, year-to-date returns have been predominantly driven by EM local currency debt, validating our overweight position in this segment. The key question now is whether this rally in EM local currency debt has already gone too far. We do not believe this to be the case for the following reasons:
1.EM real rates (i.e. adjusted for inflation) remain near multi-year highs, offering attractive valuation opportunities, particularly given manageable levels of public sector debt and contained inflation.
Figure 3: Public debt levels
Source: IMF, Macrobond, Schroders – May 2025.
2. Market sentiment towards the US dollar has undoubtedly become uniformly bearish with investors appearing to have recently increased their EM currency positioning to historically high levels. However, dollar weakness has not been enough so far to improve its real effective exchange rate valuations and our technical indicators do not exhibit any sign of the dollar becoming oversold. Our expected long-term rebalancing in global capital flows away from the US and in favour of the rest of the world still appears to be in its very early stages. In this regard, EM local currency debt has only just experienced the first positive momentum shift in flows in some considerable time. Figure 4 shows that despite recent strong performance, we have not yet seen significant reallocations by global investors, which confirms that the asset class is far from being overbought.
Figure 4: EM local bond flows vs. asset class
Source: Schroders, Bloomberg, 30 May 2025. Asset class returns represented by the JPM Government Bond Index-Emerging Markets Global Diversified.
3. EM fixed income is also supported by global financial liquidity, which remains ample and has resumed its expansion after a brief dip last quarter, as shown in figure 5.
This renewed expansion in global liquidity has been supported by the US Treasury General Account releasing more than $300 billion of liquidity since the beginning of the year. While this liquidity release is unlikely to be sustained, we expect the recent weakness of the US dollar to support global liquidity, especially if it leads to a renewed virtuous circle of expanding EM foreign exchange reserves.
Figure 5: Global real money growth (%)
Source: Schroders, Bloomberg, LSEG Data & Analytics, May 2025.
4. By combining these global factors with our bottom-up analysis of EM countries, we have estimated 12-month expected returns for EM local bonds and currencies (Figure 6). The scatter plot illustrates expected returns for each market relative to the scores assigned by our investment process, which incorporates fundamental, quantitative, technical, and sentiment factors. These scores reflect our level of conviction in achieving the projected returns, which average approximately 11% over the next 12 months.
Figure 6: EM local bond and currencies – 12 month expected returns versus investment process scores
Source: LSEG Data & Analytics, Schroders – 30 May 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.
This document contains ‘forward-looking’ information, such as forecasts or projections. Please note that any such information is not a guarantee of any future performance and there is no assurance that any forecast or projection will be realised.
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