Despite our reduced conviction in a weaker USD for 2026, we believe emerging market (EM) local-currency bonds remain well-positioned. Ongoing disinflation in EM economies not only supports EM currencies but should also enable some EM central banks to cut interest rates in 2026. We believe EM FX can perform well even with a sideways USD given the healthy state of external accounts in most EM countries.
In 2025, EM local-currency bonds posted a 19.3% total return (valued in USD), the highest among EM fixed income and the best since 2009. While the asset class performed well throughout the year, its outperformance relative to EM hard-currency peers was primarily driven by a 10.4% decline in the USD during the first half of the year. In the second half of 2025, total returns for EM local-currency bonds were between EM corporate bonds (CEMBI BD) and EM hard-currency sovereign bonds (EMBIG Diversified).
We have maintained a bearish outlook on the USD and a bullish stance on EM local-currency since Liberation Day, driven by four factors:
- Expectations that the US economy would be more adversely affected than the rest of the world by the imposition of tariffs on its trading partners;
- Narrower interest rate differentials, as a weaker US economy would prompt the Fed to resume rate cuts while other developed market (DM) central banks remain on hold or are hiking rates (e.g., the Bank of Japan);
- Diminished confidence in US institutions due to unpredictable policies; and
- The disinflationary impact of tariffs on the rest of the world.
Read the full ‘Thought Leadership’ article at the link below
Supporting documents
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