Emerging market debt: All eyes on the US

This article is an extract from our Q3 2025 Active Fixed Income outlook.

The past: what just happened?

Despite the extreme volatility in fixed income markets this year, emerging market debt (EMD) has delivered positive returns. At the beginning of June, year-to-date returns stood at 3.4% for EM hard currency sovereigns and 2.6% for EM hard currency corporates.[1] These returns have been primarily driven by US Treasuries, although resilient spreads have also contributed positively.

Within sovereigns, high yield issuers, particularly distressed names, continue to outperform. In the corporate sector, investment grade and BB issuers have outperformed B and lower-rated issuers. EM local markets have led the pack with total returns of 9.7%[2], benefiting from US dollar weakness.

The present: Implication of US policy

Since peaking in April after ‘Liberation Day’, EM spreads have recovered ground as the Trump administration appeared to back away from tariffs, at least momentarily. This has led markets to price in lower recession risks in the US and globally. At the current levels, EM spreads remain on the tight end compared to levels we would historically associate with periods of US/global recession. That said, all-in yields remain in our view very attractive with sovereign index at 7.9% and corporate index at 7.0%, which should help counter any spread widening from current levels.[3]

The IMF Spring Meetings have led to a flurry of updates to EM macro forecasts. The IMF has lowered global, advanced economies and emerging market economic growth for 2025 by 50bps across the board.[4] Markdowns are driven by and concentrated in countries with the largest exposures to the US, including Mexico (the only major EM to see a recession this year), China, EM Asia and MENA, the latter reflecting lower oil price forecasts.

However, these mark downs are not significant with the headline 3.7% growth in emerging markets flat to 2019 and in line with post-Covid averages. Further still, IMF forecasts were made in mid-April – at the peak of negativity – and hence there is room for upward revisions.

The latter, coupled with the resilience displayed by emerging markets – fundamentally and as an asset class – through multiple crises over the last decade, should help temper the extent of any spread widening.

Outlook

In the coming weeks and months, the market’s focus is likely to remain on US trade deals and tariff policies, the impact of tax cuts on US public finances and consequently the impact on the rates market and the trajectory of the US dollar.

Given uncertainties and back-and-forth on many of these issues, we remain relatively cautious in our beta, running a moderate overweight via credits and countries more insulated from tariff impact. We are also neutral on duration, focusing on the short end of EM credits where we have strong convictions. With attractive technicals and all-in yield valuations, we think idiosyncratic risks in emerging markets are manageable given the buffers available, with the primary risk factor being US macroeconomic conditions and market dynamics.

What could go wrong?

While the trade policy drama has overshadowed US inflation concerns, price pressures remain elevated, which is serving to keep the US Federal Reserve cautious for now. The potential tariff impact on the US fiscal situation has put pressure on long-term interest rates, causing curve steepening. All this could lead to further rates volatility. More positively, at least for developed market interest rates, oil prices remain weak, the persistence of which would increase macro pressures in EM oil exporters.

This article is an extract from our Q3 2025 Active Fixed Income outlook.

[1] Source: Bloomberg as at 3 June 2025.
[2] Source: Bloomberg as at 3 June 2025.
[3] Source: Bloomberg as at 3 June 2025.
[4] Source: IMF, April 2025.