The temporary truce announced between the United States and Iran has provided relief across financial markets, resulting in a strong rally across global equity and bond markets and a significant depreciation in oil and gas prices. Stagflation concerns have receded to an extent, with a more supportive inflation outlook prompting investors to begin repricing more dovish expectations across several developed market and emerging market (EM) central banks. At the time of writing, EM hard-currency sovereign and corporate spreads have retraced to pre-war levels seen at the end of February. Meanwhile, EM foreign exchange has rebounded, led by currencies worst affected during this period of market stress, such as the Hungarian forint and the Chilean peso. In domestic interest-rate markets, EM local-currency bond yields have also declined, although still above pre-war levels.
In our analysis, recent global events and financial markets’ reaction have provided two key takeaways. First, many observers underestimated Iran’s strategic leverage over the Strait of Hormuz. The Iranian regime has threatened to close the Strait before but has never followed through. A threshold to cause meaningful disruption has now been crossed. Absent a durable peace settlement, the Strait will likely remain a key source of ongoing uncertainty to regional stability in the Middle East and the smooth functioning of global energy markets.
Consequently, we expect global energy prices to remain above their pre-war levels for the remainder of the year, with the longer-term implications probably resulting in an ongoing structural shift toward countries diversifying energy supply and securing national self-sufficiency. A year on from “Liberation Day,” the reordering underway in global goods trade is likely to extend to energy markets. Asia is most exposed to constrained flows through the Strait of Hormuz but remains a relatively small component of EM sovereign-credit indexes. Europe, having borne the initial shock, is now better positioned following diversification of liquefied natural gas supply, while commodity-rich Latin America appears comparatively insulated.
Second, EM investors appear to be more impervious to headline noise, indicated by the relatively contained EM hard-currency spread widening in response to the conflict. Questions about investor complacency inevitably arise, given a larger downside tail risk. Even prior to the Iranian conflict, the pricing of a more optimistic “goldilocks” global environment was vulnerable to challenge, as was risk sentiment, due to concerns about AI-related disruption to software equity valuations and signs of stress in private credit markets.
Nonetheless, balanced against the risks, we assess that the EM debt asset class is in a fundamentally resilient position, evidenced by a sustained trend of upward sovereign-rating momentum. Pandemic-related debt restructuring has largely concluded, while countries have taken meaningful steps to deliver reform and fiscal consolidation, thereby bolstering their external buffers. Despite an expected global slowdown, EM growth continues to outpace developed markets materially: 3.9% versus 1.8% in 2026 and 4.2% versus 1.7% in 2027, according to International Monetary Fund projections.1
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Furthermore, the risk of runaway global inflation is lower compared to 2022, when the Russia-Ukraine war converged with a post‑pandemic economy of pent‑up demand and government stimulus. Policy rates across the world are relatively more restrictive today, while less fiscal policy flexibility and easing labor market pressures should help to offset inflation risk. Many EM central banks also have higher real-yield buffers, providing some protection against an unexpected deterioration in the external environment.
Importantly, capital markets remain open—even for more fragile issuers—as demonstrated by recent debut issuances from the Democratic Republic of Congo and Republika Srpska (Bosnia Herzegovina). In addition, strong issuance in January and February has meant that many issuers have already met a significant portion of their funding needs, particularly several vulnerable credits that sought to take advantage of favorable conditions. Looking ahead, remaining issuance is skewed toward higher-quality borrowers, while upcoming repayment obligations appear broadly manageable, in our opinion. Although retail demand has softened, though recovering, institutional appetite remains supportive as investors continue to seek diversification and relative value. At the same time, ongoing developments in benchmark construction and index inclusion are helping to broaden and deepen the asset class.
In the current environment, our strategy remains tilted toward hard-currency over local-currency bonds. We assess that higher-yielding sovereign bond markets offer greater performance potential. Reform stories remain broadly on track, despite stagnation among a few higher-quality credits, while political developments should provide additional support—for example, Hungary’s recent election and anticipated political shifts in Latin America through 2026. We favor issuers with strong idiosyncratic drivers and low beta relative to broader market sentiment, particularly in Africa and Latin America. Specifically, we believe that progress toward debt restructuring talks in Venezuela will likely be a key driver of overall EM hard-currency bond performance.
Our local-currency bond exposure remains selective. Inflation has been edging higher across EM countries but is not yet a dominant concern. Central banks largely remain on hold, waiting to assess whether pressures prove transitory, although some markets have begun pricing in modest rate hikes. Our preference is focused on bond markets offering high real yields, which should help to anchor inflation expectations and support investor flows, thereby providing some insulation against risk events. We are mindful that EM local-currency assets are structurally more volatile than hard-currency assets, as was clearly demonstrated throughout March.
Elsewhere, we believe EM corporate nominal yields remain attractive, despite tight spreads, particularly in less well-followed segments and select local-currency bond markets. Even before the current geopolitical crisis, we were relatively cautious about higher-yielding commodity-exposed issuers, preferring sectors such as financials. Leverage and margins remain stable across the EM corporate asset class, and we believe that issuer-specific vulnerabilities in Latin America do not signal broader systemic risk.
EndNotes
1. There is no assurance that any estimate, forecast or projection will be realized.
WHAT ARE THE RISKS?
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Fixed income securities involve interest rate, credit, inflation and reinvestment risks, and possible loss of principal. As interest rates rise, the value of fixed income securities falls.
International investments are subject to special risks, including currency fluctuations and social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets.
Commodity-related investments are subject to additional risks such as commodity index volatility, investor speculation, interest rates, weather, tax and regulatory developments.
Currency management strategies could result in losses if currencies do not perform as expected.
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