An EMD paradox
Spreads are at their tightest in history, though powerful risk mitigants remain. Low default rates, reasonably high all-in yields, and investor appetite for carry provide support to the asset class.
Geopolitical trends
The EM landscape is being re-shaped under the Trump administration’s transactional approach, with the backing of more ideologically-aligned leaders creating asymmetric opportunities. Greenland was a recent talking point, albeit it’s a distinctly Europe-centric issue, while we see the Middle East's emergence as an economic superpower as a key trend.
Growth, inflation, and policy shifts
EM inflation will likely stabilise near central bank targets and inflation is trending down. A moderate path of rate cuts is likely in H1 2026, particularly in high yielding countries driven by domestic conditions. Looking at growth, EM ex-China is expected to maintain trend-like momentum, while China is projected to slow. Moderating inflation, supportive monetary policy, and resilient growth create an environment where carry is the dominant return driver.
The dollar’s trajectory
A bearish USD trend is expected to persist this year, supported by rich valuations, heavy global positioning in USD assets, the waning of US exceptionalism as growth normalises, and rate cuts eroding the USD’s carry advantage. Overall, we forecast a modest decline in the USD, which should sustain positive EM inflows.
Local markets opportunity
EM local currency debt now represents 90% of EM issuance and the outlook is attractive. In a weaker USD environment, investors can access compelling carry, while positioning for gains in FX and diversifying away from USD-denominated assets.
Selectivity matters
An active approach is key to generating alpha in EMD. Fundamentals remain robust overall for EM corporates, while in sovereigns, we expect default rates to remain below historical averages this year.
