Mid-Year 2026 Investment View: EM Debt

Summary

• Renewed inflation pressure has changed the market narrative, with higher energy and input costs challenging the earlier disinflation story.

• Hard-currency high yield has proved more resilient than local duration, supported by attractive carry, resilient fundamentals and tighter spreads.

• Local market opportunities remain, but our focus is on higher-yielding countries, emerging market (EM) FX and frontier markets rather than broad duration exposure.

• Country and security selection are becoming more important, with idiosyncratic opportunities in reform stories and selected oil exporters.

What did H1 change for EM debt?

The key change was a shift in the inflation narrative. Entering 2026, markets expected inflation to bottom out or continue moderating, allowing central banks to stay on hold or ease policy gradually. Instead, the Iran conflict and resulting oil shock accelerated the rebound in inflation expectations, with higher energy prices feeding through to transport, food and other input costs. The risk of a Super El Niño, which would add further upward pressure to food prices, also reinforced concerns that inflation could remain stickier for longer. While growth outside the Middle East remained relatively resilient, markets are increasingly pricing a higher-for-longer rate environment.

This prompted several emerging market central banks, including Indonesia, the Philippines and South Africa, to raise rates sooner than expected. The outlook for duration has therefore become more challenging for both the US and some local markets.

Market leadership also changed. EM local debt had outperformed over the previous 18 months but gave back some gains as a stronger US dollar weighed on EM currencies. With inflation creeping higher, local rates also underperformed. In contrast, EM hard currency debt – particularly high yield – proved more resilient, with spreads recovering quickly and now trading even tighter than before the start of the conflict. The improved outlook for oil exporters, particularly outside the GCC, marked another important shift, with stronger fiscal and external balances supporting credit fundamentals. More broadly, resilient global growth, continued AI-led capital expenditure and the fact that tariffs are expected to be largely absorbed by emerging economies is helping to support EM fundamentals.

Where does the risk/reward still look attractive?

Despite tighter valuations, emerging market debt continues to offer attractive income and all-in yields relative to developed markets. Although credit spreads are historically tight, higher underlying government bond yields mean all-in yields remain close to multi-year highs, continuing to provide attractive compensation for investors. We believe the best opportunities remain in shorter-dated high yield hard currency debt, particularly in corporate issuers where carry remains compelling and balance sheets are generally resilient. While spread compression is likely to moderate from here, there is still scope for further high yield versus investment grade convergence against a strong global growth backdrop.

Within local markets, we prefer higher-yielding countries over lower-yielding markets. In an environment of rising inflation expectations and higher US Treasury yields, the carry available in higher-yielding local markets provides a stronger cushion against volatility. We also favour EM currencies over local duration in these markets.

Frontier local markets remain attractive given their combination of high real yields, attractive carry and relatively low sensitivity to global macro factors. We also continue to favour oil-exporting economies, where markets appear to have priced in a rapid normalisation in oil prices despite ongoing logistical constraints that could keep supply tighter than expected.

What remains investable across scenarios?

Given uncertainty around geopolitics, oil prices, global growth and Federal Reserve policy, we continue to focus on areas where returns rely less on any single macro outcome.

The strongest opportunity remains short-dated hard currency credit, where attractive yields and carry provide a meaningful portion of expected returns. Continued AI-led investment and resilient global growth should also remain supportive of EM fundamentals, while revised tariffs are likely to be taken in the stride of most emerging economies. Select opportunities also remain in high yield sovereigns where fundamentals continue to improve.

We also see attractive idiosyncratic opportunities in countries undergoing structural or political change, including Colombia, Peru and Hungary, where domestic reforms and changing policy settings could support asset prices independently of the global backdrop.

Frontier local markets continue to offer attractive carry with relatively low macro beta, while selected oil exporters remain well positioned, as fiscal and external balances should continue to benefit from elevated energy prices relative to historical averages.

Overall, the opportunity set has become increasingly driven by country and security selection rather than broad market beta.

How are you positioned, and where would you add if volatility creates better entry points?

We have reduced overall portfolio beta while maintaining an overweight to those areas offering the most attractive risk-adjusted carry.

Our positioning reflects an overweight to high yield hard currency debt, frontier local rates and selected local markets, particularly in Latin America and CEE. At the same time, we remain underweight duration given the more challenging inflation outlook and underweight investment grade where valuations appear less compelling.

Should volatility create better entry points, we would look to add selectively to high yield hard currency credit, particularly at the short end of the curve, as well as higher-yielding local markets where valuations become more attractive. We would also seek opportunities in selected oil exporters if spreads widen on broader market risk aversion rather than deteriorating fundamentals.

Areas where we remain cautious include long-duration hard currency bonds, low-yielding local markets that are more vulnerable to higher global rates, countries with external balances negatively affected by higher oil prices, and Brazil given the uncertainty surrounding the upcoming election cycle.

Return to Mid-Year 2026 Investment View