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          Fixed Income Insights

          How I learned to stop worrying and love EM local currency

          ZP
          Zsolt Papp
          Published: 05/27/2025
          “Now let's get this thing on the hump — we got some flyin' to do.” (Major T. J. "King" Kong in Dr. Strangelove or: How I Learned to Stop Worrying and Love the Bomb)

          Trade of the year

          Emerging Market (EM) local currency has been the fixed income trade of the year so far. This was not necessarily expected; in fact, sell-side analysts preferred EM credit (especially corporate) over EM local currency. As of May 15th, the picture couldn’t be more different: EM local currency is well ahead of EM sovereign and EM corporate credit.

          As the table above shows, EM local currency debt has outperformed other fixed income sectors so far this year. The reference index, JPM GBI-EM Global Diversified, is up 8.6% year-to-date (YTD) as of May 20th, driven, in almost equal parts, by Rates and foreign exchange (FX). It’s not only a USD story. In addition, the performance has been remarkably consistent, with local currency leading every month except February, where it was second.

          Carry On Local

          The EM yield story has been well documented, but we believe it makes sense to recap it. As illustrated in the chart below, EM countries offer significantly higher nominal yields. At the current moment, the average yield in Brazil, for example, stands at 14.2% and the average yield in Mexico stands at 9.5%. Asian and European EM countries are also offering attracting all-in yields as illustrated by Indonesia, India and Romania.

          Crucially, real yields are also elevated in many emerging markets. Brazil, South Africa and Mexico stand out with real yields of 6-8%, reflecting prudent monetary policy and proactive central banks. Even lower-yielding countries, such as Indonesia or India, offer attractive real yields. In contrast, both nominal and real yields in the Eurozone, for example Italy or Germany, are visibly lower.

          What about the USD? Not as important as one might think

          It is often assumed that a weaker USD is essential for positive EM local currency returns. However, this perspective ignores the fact that since the Global Financial Crisis in 2008, EM local currency has returned 86% despite the USD index (DXY) appreciating by 17% during the same period, as shown in the chart below. While USD fluctuations are not irrelevant, their actual impact is less important than generally perceived. A softer USD can help, just as sharp unexpected appreciation can create headwind. Overall, though, EM local currency tends to perform positively in most USD environments.

          As we mention elsewhere in more detail (Breaking the beta myth: The untapped alpha in EM Local Currency Debt), EM local currency debt has profoundly evolved in the last 25 years. Not only has the number of countries in the industry standard JPM GBI-EM Global Diversified index expanded from 11 in 2003 to 19 today, but, moreover, the weight of higher beta markets such as Brazil, South Africa and Turkey has decreased materially. In January 2006, these three markets accounted for 30% of the index, but by April 2025 their combined weight had nearly halved to 15.3%. Instead, lower beta markets such as India and China have joined the index with a combined weight of 20%.

          Another factor often overlooked is the important role played by sophisticated local institutional investors such as insurance companies, pension funds or banks. The dependence on off-shore investors has markedly decreased, leading to an increased prominence of domestic players and, consequently, local macro drivers.

          As a result, EM local offers a diversified source of alpha. The table below shows betas and correlations against a selection of other fixed income asset classes, as well as the USD and crude oil.

          Why now?

          U.S. exceptionalism, whether real or perceived, probably posed the biggest headwind to all non-U.S. asset classes. However, looking ahead, the case for US exceptionalism appears increasingly uncertain. Moody’s said in its decision to downgrade the sovereign rating to Aa1 from Aaa that “We do not believe that material multi-year reductions in mandatory spending and deficits will result from current fiscal proposals under consideration. Over the next decade, we expect larger deficits as entitlement spending rises while government revenue remains broadly flat. In turn, persistent, large fiscal deficits will drive the government's debt and interest burden higher. The US' fiscal performance is likely to deteriorate relative to its own past and compared to other highly-rated sovereigns.”

          This scenario may encourage both non-U.S. and U.S. investors alike to further diversify fixed income portfolios. EM local currency offers potentially  compelling reasons for investment, including  attractive nominal and real yields, a supportive macro story backed by higher growth than developed markets, disinflation and the potential for central banks to cut interest rates. Additionally, EM local currency could provide diversification to developed market fixed income and return potential from Rates and FX. A softer USD, which many observers expect, could provide additional tailwind. This is also reflected in weekly flows to the asset class, which, apart from the first half of April, have been positive since February.

          Emerging markets present potential investment opportunities due to their lower valuations and improved financial stability. Countries like Brazil, India, China and nations in Southeast Asia are positioned for growth, driven by economic reforms and strategic positioning in global supply chains. We believe that investors looking to diversify across both developed and emerging markets to potentially mitigate risks and capitalize on long-term growth prospects should consider adding EM local currency.

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