EM Local Currency Bonds Shine as U.S. Dollar and Rates Wobble
10 June 2025
Read Time 3 MIN
Emerging markets (EM) local currency sovereign bonds have strongly outperformed other major global fixed income asset classes this year. The U.S. dollar has been notably weak year to date through 13 May, 2025, declining approximately 7% versus a basket of developed markets trading partners1. However, the strength of emerging markets currencies, which have gained approximately 4% year to date2, only explains about half of the return this year of the JP Morgan GBE EM Core Index. The remainder of the return this year is explained by local interest rates and bond price movements, with a yield of over 7% generating significant income return3. Investors should remember that past performance is not significative of future results, and that investing in emerging markets bonds involves risks, such as the foreign currency risk, credit risk and the risk of investing in emerging markets issuers.
EM Local Currency Bonds Have Strongly Outpaced Most Of Their Peers
Source: J.P. Morgan and ICE Data Indices as of 13/05/2025. EM Local Sov represented by J.P. Morgan GBI-EM Global Core Index; Global Broad Market represented by ICE BofA Global Broad Market Index; EM USD Sov represented by J.P. Morgan EMBI Global Diversified Index; Global DM Sov represented by ICE BofA Developed Markets Sovereign Bond Index; US HY Corp represented by ICE BofA US High Yield Index; US Broad Market represented by ICE BofA US Broad Market Index; US IG Corp represented by ICE BofA US Corporate Index. Investors should remember that past performance is not significative of future results. It is not possible to directly invest in an index.
EM local bonds lagged most other fixed income in the first five years of the past decade. However since then, they have outperformed all of the segments shown above, other than U.S. high yield corporates and U.S. dollar-denominated EM sovereign bonds4. However recent performance of EM local bonds stands out, particularly following the U.S. tariff announcement on 2 April, 2025, or “Liberation Day,” when U.S. rates increased sharply while the U.S. dollar also depreciated. Several possible explanations for the weakness in U.S. fixed income (and U.S dollar assets generally) have been put forth including a decline of confidence in U.S. institutions and doubts around the U.S. dollar’s role as a reserve currency, unwinds of leveraged basis trades and selling of U.S. Treasuries by foreign central banks. It is possible that a combination of these or other factors explain what has been observed. In any case, we believe the case for diversification outside of U.S. rates and the U.S. dollar has become stronger, and EM local currency bonds are an attractive way to achieve this within a fixed income portfolio.
In addition to diversification benefits, we believe EM fundamentals could also justify an allocation to EM local bonds. Developed markets economies can be characterized by very high debt-to-GDP ratios, fiscal deficits, and increasing political dysfunction. In addition to lower debt levels and more disciplined fiscal policy, emerging markets have benefited from independent central banks that have prioritized keeping inflation under control. For example, most EM central banks hiked policy rates swiftly and decisively soon after the COVID pandemic started, getting ahead of inflation5. The results have been both high real and nominal interest rates. Sticky inflation and geopolitical conflict may also keep commodity prices elevated, benefiting the currencies of commodity exporting countries such as Brazil, Indonesia, and South Africa.
EM bond mutual fund and ETF flows have been significantly negative over the past several years6, indicating that many investors remain underallocated to the asset class. As a result, renewed interest may set up a favorable technical backdrop. Along with favorable fundamentals, the ability to diversify away from U.S. rate and dollar risk, and achieve a yield of over 7%, we believe it could be worth taking another look at EM local currency bonds. As mentioned, investors should nevertheless keep in mind the risks associate to this investment class, such as the foreign currency risk, credit risk and the risk of investing in emerging markets issuers.
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1 Source: Bloomberg data.
2 Source: Bloomberg data.
3 Source: JP Morgan, ICE.
4 Source: Bloomberg data.
5 Source: VanEck.
6 Source: Morningstar Direct, as of 4/30/2025.
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This is a marketing communication. Please refer to the prospectus of the UCITS and to the KID before making any final investment decisions.
This information originates from VanEck (Europe) GmbH, which has been appointed as distributor of VanEck products in Europe by the Management Company VanEck Asset Management B.V., incorporated under Dutch law and registered with the Dutch Authority for the Financial Markets (AFM). VanEck (Europe) GmbH with registered address at Kreuznacher Str. 30, 60486 Frankfurt, Germany, is a financial services provider regulated by the Federal Financial Supervisory Authority in Germany (BaFin).
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