Emerging market debt: resilience amid increasing uncertainty

This article is an extract from our Q2 2026 Active Fixed Income Outlook.

The past – What has just happened?

After a strong start to the year, the Iran war has led emerging market debt (EMD) to pare back some of its gains, though the asset class has demonstrated resilience. As of 12 March, EM hard currency sovereign bonds had returned 0.4% year
to-date, while corporates were up 0.7%. These gains were largely driven by the high yield segment, with carry playing a significant role, while the rates sell-off  weighed on investment grade performance. Over the same period, EM local markets underperformed, delivering a -0.4% return, primarily due to a stronger US dollar in March.

The present – positioning and performance

As noted earlier, EM spreads rebounded sharply in mid March following the initial sell off triggered by the conflict. In context, the hard currency sovereign index is only 4 basis points (bps) wider year to date, while the hard currency corporate index is 1bp tighter (as of 12 March).

A key factor underpinning this resilience has been the continuation of inflows into the asset class, with the first week of March recording a faster pace of inflows than both January and February. Ratings momentum has also remained supportive, with EM upgrades exceeding downgrades for the 27th consecutive month, including during the week in which the conflict began. This backdrop has supported record issuance, already approaching one third of full year broker estimates. Despite tight valuations and low cash buffers, new issues have attracted large order books and have generally performed well in the secondary market.

Importantly, EM entered the conflict from a position of relative strength. Growth remains resilient, inflation is on a downward trajectory, and public finances have benefited from strong nominal growth, easing monetary cycles, and debt ratios that remain well below those of developed markets. External positions are also robust, with EM as a whole running current account surpluses, supported not only by strong trade balances but also by resilient remittance flows. 

Outlook 

On 8 April, the US and Iran agreed to a two week conditional ceasefire. However, if the conflict persists afterwards, disruptions to oil and gas markets will weigh on EMs via higher commodity prices – for hydrocarbons and fertilisers, in particular – and from the hit to global markets and investor sentiments. On a regional basis, EM Asia and the Middle East are particularly vulnerable given the former is a net energy importer, while hydrocarbon production and exports from the Gulf sovereigns are being impacted by supply disruptions in the Strait of Hormuz. That said, many sovereigns in both regions have strong balance sheets, reflected in investment grade ratings and large buffers of sovereign assets.

Our EMD portfolios were underweight Middle East at the beginning of the recent escalations in region. This reflected our view that elevated geopolitical risks were not adequately priced into regional valuations amid record issuance from the most exposed issuers.

Our overall beta was relatively modest and declining given overall valuations, with our core exposure comprising credits anchored by economic reforms, International 
Monetary Fund programmes providing financing along with policy support and/or favourable commodity endowments. Our beta remains modest, while we have used the sell off to partially reduce underweights in weaker credits or add selectively to positions we like in a gradual manner. 

Meanwhile, the potential inflationary impact of higher oil prices in the US has tempered expectations for US Federal Reserve interest rate cuts. As a result, we remain cautious on duration and continue to keep it broadly in line with benchmarks across our portfolios.

What could go wrong? 

A sustained ceasefire that culminates in a peace agreement acceptable to all sides still faces considerable uncertainties. Further, the current Iran war is unfolding against a range of challenges including elevated AI-related issuance, emerging 
stresses in private credit markets, and historically tight EM spreads, particularly within investment grade. Markets appear complacent on these fronts, in our view, and too quick to assume that the Iran conflict will be short lived. If this does not turn out to be the case, the global ramifications will be more pronounced, with longer disruptions to hydrocarbon and chemicals/fertiliser supplies implying higher prices, which will filter through to higher inflation, and a broader risk off across 
asset classes. These uncertainties have led us to reduce our 
overall risk score to neutral from +1.

This article is an extract from our Q2 2026 Active Fixed Income Outlook.

Key risk

Assumptions, opinions and estimates are provided for illustrative purposes only. The value of an investment and any income taken from it is not guaranteed and can go down as well as up, and the investor may get back less than the original amount invested. There is no guarantee that any forecasts made will come to pass.