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EM debt markets continued their yearlong rally, powered by falling rates and demand for non-U.S. assets."
In the third quarter, emerging markets (EM) debt markets continued their yearlong rally, supported by a weakening U.S. dollar, easing monetary policy, strong country fundamentals and ongoing investor demand for non-U.S. assets. Looking ahead, positive fundamentals and favorable real yields versus developed markets point to a constructive outlook for EM debt.
EM debt performance in the third quarter was boosted by positive contributions from almost all the risk factors that drive returns for the local currency sovereign, hard currency sovereign and corporate EM debt segments. Despite a modest rebound in July, the weakening U.S. dollar was broadly supportive for EM currencies, while sovereign credit tightened and EM rates outperformed global rates.
World debt markets were buoyed by the broad trend toward lower policy rates. The U.S. Federal Reserve lowered the federal funds rate by 25 basis points (bps) in September, and 14 other central banks, in both developed and emerging markets, also moved to ease monetary policy.
Improving investor sentiment toward non-U.S. assets benefited EM debt, which posted its 10th straight week of inflows as of quarter-end. Hard currency strategies gained $7 billion, while local currency added $4.3 billion. This is a sharp contrast to the first four months of the year, which saw large outflows. Investors remained concerned about the weakness in the U.S. labor market, continued policy uncertainty, and various unpredictable tariff announcements.
Tariff uncertainty and global conflicts persisted
Tariffs remained a major wild card for the world’s economy. During the quarter, China displayed a strong negotiating position with the U.S., using rare earth metals, TikTok and a potential meeting with President Xi Jinping as leverage. At the end of October, President Trump and President Xi reached an agreement in which overall U.S. tariffs would be set at 47%. Trump also imposed higher tariffs on India and Brazil. The third quarter also saw countries work to strengthen ex-U.S. trade. In July, for example, the UK and India signed a free-trade agreement, and China offered tariff-free access to 53 African nations. The EU, Indonesia and Japan also established new trade agreements.
In Argentina, President Javier Milei—a strong Trump ally—scored a decisive political victory in October after his party’s weaker-than-expected results in Buenos Aires’ September midterm election.
In early September, Israel launched an airstrike on Doha targeting Hamas leaders, which was met with pushback, particularly from the Gulf region. As Russia’s war against Ukraine ground on, President Trump said he was disappointed with Putin and urged the EU to keep supplying weapons to Ukraine.
A rally in EM rates
Performance for the underlying EMD risk factors were positive (Display 1), though for the local segment of the asset class, gains were more modest than in the first half of the year. EM currencies had mixed performance at the individual country level but still contributed positively to total return. EM rates rallied, driven by a handful of big benchmark countries, including Mexico, South Africa and Indonesia. For the hard currency segment, substantially all the gains came from sovereign and corporate spread tightening and declining U.S. rates. The hard currency corporate segment similarly benefited from spread tightening and declining U.S. rates.
Falling rates and spread compression accounted for most of EM debt 3Q gains
Falling rates and spread compression accounted for most of EM debt 3Q gains
Display 1
Year-end outlook
We believe the pick-up in demand for EM assets is likely to continue, as investors look outside the U.S. in the face of ongoing policy uncertainty. The Fed’s easing cycle, which began in September, further supports attractive relative valuations of non-U.S. assets. Additional rate cuts are expected for 2025 and 2026, but how many is up for debate—the Fed is caught between balancing its concern over inflation with a worsening labor market.
As we saw in the third quarter, countries are establishing trade relationships apart from the U.S., while at the same time seeking separate negotiations with the U.S. Trump and Xi continue to press for advantage, as China seeks to leverage its dominance of rare earth metals to push back on U.S. tariffs.
In the fourth quarter, we still expect to see significant value in EM debt, despite the strong performance through the first three quarters of the year. In particular, we see attractive valuations in currencies and local rates.
Bottom line: Overall, we expect a weaker U.S. dollar and strong individual country fundamentals will continue to support EM performance. Real yield differentials also favor developing over developed markets. EM issuers represent an expanding opportunity set—especially those outside of the major benchmarks—but require significant analytical expertise. As always, we will continue to focus on differentiation among countries and credits as the best way to deliver EM value for our portfolios.
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