Emerging market debt: Momentum backed by fundamentals

This article is an extract from our Q4 2025 Active Fixed Income outlook.

The past – what just happened? 

Emerging market debt (EMD) has performed impressively in 2025 so far, delivering robust returns despite global volatility. As of 12 September, emerging market (EM) hard currency sovereigns have returned 10.6% year-to-date, while corporates have gained 7.2%. These gains have largely been driven by movements in US Treasuries, with additional support from modest spread tightening – especially in the high-yield segment. EM local markets have outperformed, posting a 15.4% return, buoyed by a weaker US dollar.

The present – high carry, solid fundamentals

EM fundamentals remain strong, with positive credit ratings momentum continuing as upgrades outpace downgrades. Notably, there were no EM sovereign defaults in 2024 and year to date in 2025 so far, while the number of corporate defaults have declined versus previous years.

This speaks to macroeconomic dynamics continuing to support emerging nations. The International Monetary Fund projects EM growth at around 4% for 2025, outpacing the ~1.5% anticipated for the advanced economies, such as the US, UK, Japan and Germany. Inflation in EM continues to trend downwards and many EM central banks now have room to cut rates or have already begun cutting (e.g. in Latin America).

On the external front, commodity prices have been relatively firm, supported by demand and constrained supply, which has benefitted EM commodity exporters. For oil-importing EMs (mostly in Asia), the good news is that oil prices have not spiked and in fact remained within a moderate range, easing pressures on trade balances. These trade surpluses have underpinned continued surpluses on the current account this year, which will aid the continued building of foreign exchange reserves, already at record levels.

Meanwhile, despite the record level of issuance in primary markets, EM spreads are tight, leaving limited room for further compression. Investment-grade spreads are near their tightest levels since 2007. In contrast, we believe high-yield EM spreads still offer relative value compared to historical levels and to US and Euro high yield. This said, even after this year’s spread rally, in our view yields remain attractive—7.1% for sovereigns and 6.3% for corporates—providing a cushion against any potential spread widening.

Outlook 

On 17 September, the US Federal Reserve (Fed) cut interest rates for the first time this year, by 25 basis points. This interest rate-cutting cycle is expected to be a tailwind for EM assets. Since 2007, EMD has delivered positive returns in every Fed cutting cycle except during the 2008 financial crisis.

Another factor working in favour of the asset class is technicals. Investor positioning is still cautious relative to the improving fundamentals, meaning many investors under-invested in EMD. This is starting to change: over the past few months, fund flows into EM bond funds have increased as allocations have increased, including from crossover accounts. Clearly, policy and institutional uncertainties in the US have led some global investors to diversify into EM assets, boosting inflows, attracted by the relatively high all-in yields.

What could go wrong? 

The focus for investors remains the outlook for US macro and markets. The current market narrative assumes no significant resurgence of inflation amid Fed rate cuts this year. Hence, a key risk is resurgent inflation on the back of trade tariffs which stifles market expectations around US monetary policy. Investors are also closely watching US growth dynamics with the base case assuming no recession in the near term. Thus, data releases that point to a weaker-than-expected economy would unnerve markets.

Read our Q4 2025 Active Fixed Income outlook.