We expect EM central bank easing to continue

Emerging market (EM) local currency debt is having a tremendous 2025. Through the market turmoil and geopolitical tensions, the asset class has returned over 12% so far this year, far ahead of all other fixed income markets (Source: J.P. Morgan as of June 2025). What is most interesting to us, however, is the decomposition of this return, with a roughly equal contribution coming from foreign exchange (FX) and rates. Even though the market has performed incredibly well, we believe there is still room for future growth. Again, we expect both FX and rates to contribute positively for the remainder of 2025.

A weakening US dollar has been one of the major headlines across financial markets. Investors allocated huge amounts of capital during the US exceptionalism environment that we witnessed over the past 10 years. The main driver of FX returns this year has been investors looking to either hedge their US dollar risk or diversify their assets away from the US into other countries. We understand that investors move at different speeds, with some acting very quickly while others take a while to action any allocation changes in their portfolio. As such, we think the move in the US dollar is far from over. While a weaker dollar will benefit EM investors by enhancing returns, we find there is a fundamental benefit for EM countries too. A weakening US dollar combined with lower oil prices has helped disinflation and could provide a further boost to EM local currency debt, particularly with inflation already at target levels across many emerging markets.

This FX tailwind is occurring at a time when nominal interest rates in emerging markets are high, leading to high real yields across EM local currency debt. With EM central banks having started their cutting cycle, and with inflation back to target levels, a further weakening in the US dollar provides support for EM central banks to cut rates without concern of a negative currency impact. We have high conviction in a long EM rates position, with a supportive macro backdrop leading to lower yields. Interestingly, we have found that EM rates have been less volatile than developed market rates recently. This lower volatility is partially due to the persistent domestic support from individual emerging markets for their own local currency bonds, which is providing a strong foundation and means that global investors are not alone with any new allocations. The weaker US dollar and subsequent decorrelation with US Treasuries is also a key factor in dampening volatility, boosting Sharpe ratios.

Given the supportive backdrop, we believe now is the time to act in EM local.