Fixed income
Is emerging market debt entering a new super-cycle?
6 min read 9 Oct 25
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Emerging markets (EM) are often portrayed as noisy, unpredictable, and prone to external shocks. Over the past year, the headlines have been dominated by geopolitical tensions, tariffs, and debates over US policy direction. Yet amid this uncertainty, EM debt has staged a quiet resurgence. Local currency sovereign bonds in particular, have delivered resilient returns that may have surprised investors accustomed to thinking of EM as the fragile link in the global chain.
This resilience is raising a bigger question: are we seeing the first signs of a new super-cycle for EM debt? Much like the commodity-driven boom of the early 2000s, today’s conditions suggest the asset class may be poised for a longer-term re-rating, in our view.
The Dollar at a turning point
The US dollar has long been the gravitational force in global financial markets. When the dollar strengthens, EM assets often struggle under the weight of capital outflows and higher servicing costs for dollar-denominated debt. But when the dollar weakens, the opposite tends to occur.
Today, the case for a softer dollar is building. The US faces a widening fiscal deficit, interest rate differentials with the rest of the world are narrowing, and the narrative of US exceptionalism is showing signs of fatigue. The dollar’s recent stumble – it experienced its weakest start to a year since 1973 – has already provided a powerful tailwind to EM local currency bonds.
History has shown that periods of dollar weakness often coincide with stronger returns from EM local currency bonds, as investors seek higher yields and improved fundamentals outside the US.
Fed policy as a catalyst
Monetary policy cycles often set the tone for capital flows into EM. A Federal Reserve (Fed) that is cutting rates not only weakens the dollar, but also reduces global funding costs. This combination historically favours EM local currency sovereign debt, which can offer attractive yields without the drag of a stronger dollar.
A continuation of the Fed easing cycle in 2025 is particularly important. Lower US rates ease the burden of servicing dollar-denominated debt and improve access to international markets as yields compress. For EM issuers, this often translates into a virtuous cycle: stronger demand for bonds, lower borrowing costs, and renewed investor confidence.
Fundamentals stronger than in previous cycles
One of the criticisms often levelled at EM debt is its vulnerability to policy mistakes. But in recent years, many emerging economies have strengthened their macroeconomic foundations. Inflation has generally been brought under control, reserves have risen, and monetary policy frameworks have become more credible.
We believe this differentiates the current cycle from earlier ones. Rather than being hostage to US policy cycles, EM countries are increasingly charting their own course. Independent central banks from Brazil to Indonesia have shown a willingness to raise rates pre-emptively, even ahead of the Fed, demonstrating credibility.
"Rather than being hostage to US policy cycles, EM countries are increasingly charting their own course."
In Asia, fundamentals look particularly supportive, in our opinion. China has introduced targeted stimulus measures to stabilise growth. India continues to grow at one of the fastest rates globally, supported by fiscal reforms and infrastructure spending. Southeast Asian economies such as Indonesia and the Philippines offer attractive carry underpinned by resilient domestic demand.
Structural shifts underpinning the case
Beyond cyclical drivers, structural changes are reshaping the landscape for EM debt. Global supply chains are being reconfigured, with many multinationals pursuing a “China+1” strategy that is directing investment into other parts of Asia. This reorientation is boosting medium-term growth prospects and broadening the investor base.
At the same time, EM governments are increasingly tapping capital markets in innovative ways, including through the issuance of green and social bonds. Institutional investors seeking diversification and exposure to long-term growth themes are showing rising appetite for these instruments.
Risks on the horizon
No cycle is without risks, and investors should remain alert to potential headwinds. Inflation could re-accelerate, especially if commodity prices spike. Political risks – from elections in major EM countries to geopolitical flare-ups – could dent investor confidence. And while the US dollar appears to be on a weakening path, a sudden shift in Fed policy or a flight to safety could reverse capital flows.
It is also worth noting that while EM fundamentals have improved, disparities remain across individual countries. Selectivity and active management remain crucial.
For years, EM debt has often been treated as a tactical trade, to be entered when yields looked attractive and exited when the dollar strengthened. Today, however, the landscape is shifting. Softer dollar dynamics, credible EM policy frameworks, and structural growth shifts suggest that EM debt could merit a more permanent place in global portfolios.
Rather than being an opportunistic bet, the asset class is increasingly supported by both cyclical tailwinds and structural underpinnings. This means the question is no longer whether EM debt can deliver short-term outperformance, but whether we are entering a new phase where it forms a core allocation for investors.
* This article was first published, in Chinese, in the Hong Kong Economic Journal.
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