EMD: emerging markets benefit from global shift
By Abdallah Guezour, Head of Emerging Markets Debt and Commodities at Schroders
After three years of strong returns, EMD still has more to give, with the recent recovery in fund flow likely to gain more traction.
Global economic activity should remain firm in 2026 despite persistent global trade uncertainties, geopolitical tensions, fiscal headwinds in several developed economies and China’s disappointing growth trajectory. Although labour markets in the US and Europe have softened, abundant global liquidity, combined with strong private sector balance sheets, should continue to support growth into 2026. Emerging market (EM) exports are also showing notable resilience despite higher US trade tariffs, which is helping EM growth differentials versus the US to remain at levels historically sufficient to attract capital inflows into EM.
Inflation trends remain benign in most EM economies, supported by subdued food and energy prices and China’s continued export of deflation. With inflation well contained, EM policy rates appear too restrictive, leaving significant scope for further easing across EM regions. By contrast, the US may face stickier inflation due to delayed tariff pass-through and fiscal and monetary expansion. This could soon challenge the credibility of the US Federal Reserve’s current easing cycle.
Global financial liquidity remains ample and supportive of risk assets. Global monetary aggregates are expanding at a solid pace and could receive further support from the end of central banks’ balance sheet contraction. Foreign exchange (FX) reserves are rebuilding across several EM countries, reinforcing domestic liquidity and external resilience. EM debt is also benefiting from a gradual return of inflows after several years of outflows. These reallocations to EM debt are still in their very early stages, as global investors are still underinvested in the asset class despite its strong performance of the last three years.
The US dollar’s structural vulnerabilities have now become more visible, particularly as the greenback is starting to lose interest rate support. While dollar weakness in 2025 has led to oversold conditions in the short term, real effective exchange rate valuations are still stretched and have yet to fully reflect the unsustainable levels of the US fiscal and external deficits. The dollar is also increasingly driven by volatile equity inflows rather than stickier bond flows. Record foreign investment into US equities in 2025, especially in AI-related sectors, has increased dollar vulnerability to equity market corrections.
The commodity outlook remains broadly constructive. Oil markets are well supplied, but this is already reflected in recent price underperformance. In base metals, copper stands out as supply-demand balances have moved into deficit following major mine disruptions and expected AI related demand. Gold continues its steady bull market, supported by central bank demand and early-stage portfolio diversification flows, with no convincing evidence yet of late-cycle excesses.
Geopolitical risks remain elevated, but this does not seem to be reflected in market pricing. While hopes of a potential peace agreement in Ukraine could still lead to further risk-on response, a credible and long-lasting accord remains elusive.
Regarding the recent developments in Venezuela, initial thoughts are that the ousting of President Maduro and implied sponsorship from the US creates the potential (in a best-case scenario) for debt restructuring with attractive recovery potential. However, the road is likely to be long and complicated, especially given the political and security risks associated with regime change and the fact that a material increase in oil production in unlikely to occur anytime soon.
Market implications
Tactical long exposures to US interest duration remain justified given improved long-dated Treasury bond valuations, light positioning, and a softening US labour market. However, structural fiscal imbalances, sticky inflation and the shift towards more price-sensitive Treasury holders remain key downside risks that we continue to monitor very closely.
EM local currency debt remains our top sectoral preference for 2026 thanks to favourable inflation dynamics, high real rates and more favourable public debt dynamics in EM relative to developed markets. We still favour Brazil, Mexico, South Africa, the Philippines, and parts of Central Europe, where we have identified 12 months expected returns with the potential to exceed 10%.
Despite unattractive levels of hard currency debt spreads, selective high-yield sovereigns and corporates still offer improving credit metrics and appealing income, which could lead to more than 7% return in 2026 for this sector. Further upside potential can also still be realised in credits such as Egypt, Argentina, Angola and Nigeria.
All these sectoral views are summarised in the scorecard below:
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