EMD: Navigating geopolitics, rates volatility and valuations in a changing global regime

Middle East developments

Developments in the Middle East have been a key driver of global markets this year. Concerns over energy infrastructure and shipping routes pushed oil prices higher, increasing volatility and reigniting inflation concerns. Although periods of de-escalation have helped ease some of these pressures, uncertainty remains elevated.

For emerging markets, higher energy prices have reinforced the divergence between commodity exporters and importers. Oil-exporting sovereigns in the Middle East, Latin America and selected frontier markets have generally benefited from improved fiscal metrics, stronger external balances, and enhanced credit fundamentals, supporting both sovereign spreads and local market performance. In contrast, many oil-importing countries across Asia and parts of Africa have faced mounting pressure on current account balances, inflation expectations, and exchange rates. This has left them more vulnerable to shifts in global risk sentiment and commodity price volatility.

EM fundamentals and valuations

Despite heightened geopolitical uncertainty, emerging market debt (EMD) remained resilient during the first half of the year. Attractive carry, healthy fundamentals and strong demand for yield continued to support the asset class.

Foreign exchange reserves remain healthy across much of the emerging market universe. Access to international capital markets has remained robust, with even lower-rated and frontier issuers — including a number of CCC-rated sovereigns, such as Benin, Cameroon, Trinidad & Tobago, Angola, Democratic Republic of Congo— successfully accessing bond markets. 

In addition, multilateral institutions, such as the IMF and World Bank, continue to provide support for countries facing external financing challenges.

Inflation remains the key area of concern. Higher energy costs have fed into price pressures across many countries and have been compounded by currency weakness. 

Rising agricultural input costs and the risk of weather-related disruptions could add further pressure to food prices during the second half of the year. As a result, several emerging market central banks have become more cautious about easing monetary policy despite softer growth prospects.

As of 17 August 2026, EM local currency debt had returned 3.0% in US dollar terms year-to-date, compared with 2.6% for EM hard currency sovereign debt and 2.3% for EM hard currency corporate debt.[1]

Returns across the asset class have been driven largely by spread compression, particularly in higher-yielding segments. However, valuations have become more differentiated. Investment-grade spreads are approaching historically tight levels, limiting the scope for further compression, while we believe selective opportunities remain within high yield.

Even after recent performance, we believe all-in yields remain attractive by historical standards. In our view, elevated starting yields, resilient fundamentals and strong carry should continue to provide support for EMD despite periods of market volatility.

Supportive flows and technicals

Investor demand for EMD has remained robust despite tighter valuations. Fund flows continue to reflect healthy appetite for EM fixed income. Year-to-date inflows into EM bond funds reached approximately US$31 billion as of 14 August 2026.[2]

The technical backdrop has also been supported by positive ratings momentum, with sovereign upgrades continuing to outpace downgrades. At the same time, investors have become more focused on diversifying away from concentrated exposures such as US equities, providing an additional source of support for emerging market assets.

Issuers have taken advantage of favourable market conditions, with emerging market bond issuance reaching record levels during the first half of 2026. Importantly, the increase in supply has been readily absorbed by investors, highlighting the depth of demand supporting the asset class.

US macro

Alongside geopolitics, the path of US Treasury yields is likely, in our view, to remain one of the most important drivers of EMD performance.

Markets entered 2026 expecting a gradual Federal Reserve easing cycle, but sticky inflation, fiscal concerns and geopolitical risks have complicated that outlook. Investors have increasingly shifted their focus towards the possibility that policy may need to remain restrictive for longer should inflationary pressures persist.

In this environment, we believe duration is unlikely to be a major driver of positive returns. Unlike previous periods when falling Treasury yields provided a significant tailwind for emerging market assets, future returns are likely to depend more on carry, issuer selection and relative value opportunities.

We believe shorter duration exposures may offer a more attractive way to capture income while helping to reduce sensitivity to interest-rate volatility.

Investment implications

What does this mean for our active EMD portfolios? 

In a more complex and volatile environment, the focus shifts from market beta to alpha generation.

1.       Carry remains king: With limited scope for spread compression and uncertain duration tailwinds, we believe carry will be the primary driver of potential returns. 

2.       Greater dispersion creates opportunities: We are looking for opportunities to selectively increase beta across our portfolios. However, divergence across countries and sectors provides fertile ground for active management. Our focus, therefore, remains on credit selection rather than broad beta-based exposure.

3.       Preference for high-yield over investment grade: Targeting credits with reform stories and improving fundamentals that offer attractive potential risk-reward benefits.

4.       Preference for shorter-dated credit: Given our caution towards the outlook for US government bond yields, we prefer to look for EMD opportunities at the shorter end of the curve.

Assumptions, opinions, and estimates are provided for illustrative purposes only. There is noy guarantee that any forecast will come to pass. Past performance is not a guide to the future.

 
[1] Bloomberg, as of 17 August 2026. Past performance is not a guide to future performance.
[2] JP Morgan, EPFR data, as of 14 August 2026. Past performance is not a guide to future performance.