2025 delivered its share of global drama: U.S. tariffs, geopolitical friction from Ukraine to the Middle East, and an environment of ongoing policy uncertainty. And yet EMD defied expectations: it absorbed the noise remarkably well, buoyed by returning inflows and investor sentiment that quietly strengthened to its highest point since late 2021. Entering 2026, the backdrop looks constructive: a softer U.S. dollar bias, ongoing Federal Reserve easing, positive commodity terms of trade and improving global growth synchronisation are all aligning in emerging markets favour.
What stands out most is how familiar it all feels. Several indicators, from U.S. Treasury yields, EM spreads, to investor behaviour, display a certain resemblance to where they were in 2006. Indeed, at the time, valuations were also tight, policy uncertainty lingered, and global investors were searching markets for yield. Today's setup is not identical, but the parallels offer an intriguing framing for the year ahead.
A complicated U.S. picture, but EM still benefits
For all the focus on EM dynamics, 2026 begins with a clear truth: what happens in the first quarter in the U.S. will reverberate through global markets. The transition in the Federal Reserve leadership, Supreme Court rulings that could unsettle fiscal plans, and a wave of deferred federal spending from the "OBBBA", amidst a flurry of new measures by the Trump administration with the mid terms in mind, are key potential bifurcations in 1Q26, which will set the course for the whole year. These events carry consequences for the dollar, the Treasury curve and global liquidity which are all critical variables for EM investors.
Trump's recent choice of Kevin Warsh to lead the Fed alleviates some governance concerns, given his past as a Fed governor, although doesn't dissipate them all. Indeed, fiscal uncertainties from the potential loss of tariff related revenue to pre–mid-term spending are likely to remain. That said, we are also observing a potential broadening of US growth drivers in 2026, away from just AI, together with more convergence of growth with Europe, EMs and a steady China. This makes for a supportive environment for EM currencies to perform as the US Dollar remains stable to weaker. It also prolongs the appetite for the yield premium and diversification offered by EM sovereigns and corporate credits.
Europe lifts, China steadies
Europe had a bruising year in 2025, squeezed between weak demand, assailed by U.S. tariffs and defense spending pressures. But even here, the picture is slowly turning. Germany's €500bn infrastructure and defense package should start flowing into the economy, growth forecasts are nudging higher, and consumer balance sheets remain relatively intact. Central Europe stands to benefit most, particularly as elections in Hungary could normalise relations with the EU and in consequence unlock fresh investment.
China remains a more complex story. The country's enormous trade surplus persisted through 2025, but the export-led model is clearly reaching its limits. Domestic deflationary pressures and global resistance against cheap exports are forcing Beijing into tactical recalibration. Policy discussions are shifting towards more support for domestic consumption, a stronger renminbi, and a gradual retreat from export dumping behaviours. This shift is good news for other Asian EMs who have long struggled to compete with Chinese goods' oversupply.
EM fundamentals: Stable, disciplined, and quietly improving
Beneath the politics and headlines, EM fundamentals remain in decent shape. Many EM central banks have been proactive in hiking rates early and decisively in 2021–2022, curbing inflation earlier than the Fed and other DM central banks. They have remained particularly vigilant on exogenous trade and geopolitical risks, as well as endogenous fiscal risks. It is symptomatic that despite the advent of various waves of left- or right-wing populist governments across EMs, policy initiatives have tested but broadly remained within the boundaries of fiscal credibility (Brazil, Mexico, Turkey, Egypt, and Indonesia), while others have surprised positively on fiscal consolidation (Argentina and South Africa). Fiscal slippage exists in some places but overall, spending discipline has held. Rating upgrades once again outnumber downgrades by the sharpest margin of the past five years, a sharp reversal from the turbulence of 2022, and a witness of EMs improved fundamentals.
Balance of payments' risks also look more stable. Very few major EM economies are running wide current account deficits, and those that are, such as Romania, are on the mend thanks to significant policy adjustments and remain funded through EU inflows. Former members of the "fragile five" of 2013 (Brazil, India, Indonesia, South Africa, and Turkey) have largely stabilised their external positions. It is an environment supportive of steady credit spread tightening, even if valuations are less supportive than before.
Seven themes that we believe will shape EM Investing in 2026
1. The first quarter will define the USD and Treasury curve
The Fed leadership transition and early‑year fiscal/legal decisions in the U.S. will set the tone for the dollar and the Treasury curve. We expect episodic volatility that ultimately will benefit some EM FX.
2. EMD enters a more mature part of its rally
We prioritise income maximisation in credit and local bonds supplemented by selective idiosyncratic alpha from election cycles, reform paths (Hungary, Colombia, Brazil, and Peru for example) and corporate events (cyclical pressures in oil/commodity related sectors), whilst keeping duration disciplined and FX risk selective.
3. A 2006-style environment: Tight valuations, but robust support
US yields, Fed Funds, the Euro, or EM spreads and local yields levels are erringly similar to their late 2005 level. We feel that the grind tighter/higher in spreads and currencies is set to continue, given cash-rich technical backdrop and risk-seeking investor behaviour, all financed by bloated governments' balance sheets. Like in 2006, we expect occasional risk wobbles to occur in 2026 but should still be bought given very strong EMD technicals and our perception of continuing inflows on any dip.
4. Global growth convergence lifts EM risk appetite
A steadier U.S., a gradually improving Europe and EM growth near ~4%, with a "steady enough" China, underpin risk appetite. We lean into high real carry currencies (TRY, EGP, NGN still, but also ZAR, BRL, COP, and MXN) and credible reform stories, with also a focus on the ones supported by early year portfolio inflow dynamics (CE3, MXN, BRL, ZAR, MYR…).
5. Local duration becomes a risk-premia story
With disinflation largely advanced and rate cuts adequately priced in many places, we prefer shorter duration local bonds where fiscal anchors are improving and inflows can tighten curves relative to interest rate swaps.
6. Impact on EM investment grade (IG) credits of U.S. "hyperscalers" issuance
AI linked U.S. IG issuance may compete with U.S. crossover demand normally directed to bigger EM IG cap stacks (Saudi Arabia, Mexico, Poland, and Chile) demand, but EM IG should be buffered by local demand and Asian bid—especially in GCC (Gulf Cooperation Council). We're prepared to stand ready to buy periodic dips.
7. Reduce exposure on cyclical/oil related EM corporates
With supply ample and downside risk to spot, we have reduced direct High Yield exploration and production exposure. We express energy views via sovereigns with rebuilt cushions (Nigeria, Angola, Ecuador, and Ghana) and corporates with contracted/less price sensitive cash flows (Israel gas, Brazil floating production, storage, and offloading vessels): adding to cyclicals only at better entry levels.
A year defined by carry, discipline, and selective conviction
If 2025 was the year markets learned to ignore geopolitical noise, 2026 may be the year EM investors rediscover the value of discipline. Conditions are not exuberant, nor are they fragile, they are balanced. Income and idiosyncratic alpha should drive the bulk of returns, while market dips created by global risks, from AI valuations to private credit concerns, are likely to offer entry points rather than systemic stress.
The right approach to investing in EMD in 2026, should remain to maximize the diversified current income stream offered by the depth of the asset class, whether through hard currency credits, or short to mid duration (ex-Asia) local bonds still exhibiting higher real yields than necessary. Beyond this, a number of opportunities remain for "Alpha" generation from idiosyncratic stories around key events, whether election cycles, terms of trade shifts or refinancing exercises. 2026 may not deliver as much as 2025 but should remain a very fair performance year for EMD assets.
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Investing involves risk, including possible loss of principal. Past performance is no guarantee of future results. Fixed-income investment options are subject to interest rate risk, and their value will decline as interest rates rise. International and global investing involves greater risks such as currency fluctuations, political/social and differing accounting standards. The potential for income and return is accompanied by the possibility of loss. Inflation and other economic cycles and conditions are difficult to predict and there is no guarantee that any inflation mitigation/protection strategy will be successful.
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